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Tuesday, January 27, 2009

Russell Lee After Taxes February 1939White mother with children at migrant camp. Weslaco, TexasRussell Lee's notes: "Local employment men say that there was no need for migrant labor to handle the citrus and vegetable crops in the valley, the local supply of labor being ample for this purpose. Most of the local labor is Mexican and the labor contractors favor Mexican labor over white labor, partly because the Mexican will work much cheaper than whites. One white woman who was a permanent resident said that the white people who lived in the valley had no trouble with the Mexicans. The Mexicans were good neighbors, she said, always willing to share what they had. She said the white migrants who came into the valley and resented and misunderstood the Mexicans caused the trouble between the two races.

The Ghost of Tom Joad

Men walkin' 'long the railroad tracksGoin' someplace there's no goin' backHighway patrol choppers comin' up over the ridgeHot soup on a campfire under the bridgeShelter line stretchin' round the cornerWelcome to the new world orderFamilies sleepin' in their cars in the southwestNo home no job no peace no rest

The highway is alive tonightBut nobody's kiddin' nobody about where it goesI'm sittin' down here in the campfire lightSearchin' for the ghost of Tom Joad

He pulls prayer book out of his sleeping bagPreacher lights up a butt and takes a dragWaitin' for when the last shall be first and the first shall be lastIn a cardboard box 'neath the underpassGot a one-way ticket to the promised landYou got a hole in your belly and gun in your handSleeping on a pillow of solid rockBathin' in the city aqueduct

The highway is alive tonightBut where it's headed everybody knowsI'm sittin' down here in the campfire lightWaitin' on the ghost of Tom Joad

Now Tom said "Mom, wherever there's a cop beatin' a guyWherever a hungry newborn baby criesWhere there's a fight 'gainst the blood and hatred in the airLook for me Mom I'll be thereWherever there's somebody fightin' for a place to standOr decent job or a helpin' handWherever somebody's strugglin' to be freeLook in their eyes Mom you'll see me."

The highway is alive tonightBut nobody's kiddin' nobody about where it goesI'm sittin' downhere in the campfire lightWith the ghost of old Tom Joad

Ilargi: No, Joseph Stiglitz, you miss the point when you say "The question facing us is, to what extent do we participate in the upside return?". That is a useless question at this point in time, and if you ask me, will remain useless for at the very least the next ten years. But it doesn't even really matter whether you hope and believe that there will be some from of recovery in the economy within the next decade. There is one question that nobody asks amid all the rescues and bailouts and stimulus plans and persistent refusals to put a mark-to-market value on all liabilities and assets inside the financial system.

That question is: what do we do if and when all the plans fail to work as planned and hoped and believed? The ongoing unwillingness, across the board, to even think about that possibility is as dangerous as it is bewildering. The majority of economists, bankers and politicians will, when pressed, admit that there is no precedent for what is happening, that these measures have never been tried before, that trillions of dollars, in essence the future wealth of an entire generation, is being thrown into uncharted territory. Still, nobody talks or maybe even thinks about what will be left when the measures don't work.

So let's do a little mental exercise. For some inspiration, there's an article by Charles Hugh Smith below called "Housing As Shelter, Not Speculation". I was very happy to see that, because Charles returns to two themes I have often addressed here. The first one, which is defined by his title, I will come back to in a minute. The second one, his assertion that US home prices will fall to a level of 10-20% of their peak prices, relates to something I have been saying since before The Automatic Earth started. To be precise, my estimate has consistently been a fall in average home prices in the US of 80% or more, while Stoneleigh has maintained that it will be 90% or more. Not much of a difference, when you look up close, is it? Neither would we ever presume this will be limited to US markets: it will happen all over the western world, in Canada, England, Ireland, France, Greece, Spain, Portugal and Holland. Not even Germany, which didn't have an early millennium housing boom, would be spared. Nobody can buy a home without credit, and there is no more credit. SImple.

So that, Mr. Stiglitz, leads to the real question of our times: If we assume that the Case/Shiller index has so far fallen almost 30% (I haven't checked, but it's not far off), we are looking - in our mental exercise- at another 50%+ fall from peak prices. Now we have to wonder what that would mean for the banking system, for the mortgage-backed securities they hold (as do mutual funds, pension funds etc.), as well as for the governments and central banks that are now planning to either buy up these "assets" or to insure or guarantee them.

It should of course be clear right at first glance that such a fall in domestic real estate prices would wipe out all but a very small handful of banks, all pension funds, and more than a few of the governments, the sovereign states, that have been foolish enough to get directly involved. Other than that, it would also, through a game of financial contagion domino's, wipe out entire stock exchanges, cause many millions of jobs to be lost result in widespread rioting and force dozens of governments to run as fast as they can manage with their tails between their legs.

Once that phase has become our reality, we will be left with a wholly different reality that the one we have lived in all our lives. What will make that new reality much much worse is that our governments will have plunged us far deeper into debt than we would already have been, through the rescue plans that were implemented in the past months. Plans that were doomed from the start if you assume that Charles Hugh Smith and Stoneleigh and yours truly are right in our predictions of an 80-90% real estate price drop. Now you can try to disagree, and come up with data that show us how wrong we are. But no such data is forthcoming. Instead, the entire political and financial world simply refuses to even consider the possibility that we are right.

We still are, though. If only because there is nothing out there that can stop the prices from falling. The opposite is happening, the Case/Shiller index shows today, once again, that the decline in prices is accelerating. There are plans to let US judges "reset" mortgages to lower prices. But what prices would that be? Will the government venture to keep home prices at artificially elevated levels? Who would benefit from that? The homebuyers who wind up with homes that have another 50% to fall? The banks who have to chase them out once it's obvious "values" keep falling?

No, the whole thing is based on the same blind belief and hope systems, the Yes We Can religion, that leads you, Mr. Stiglitz, to state that "The question facing us is, to what extent do we participate in the upside return?".

Mr. Smith has it right when he says that we need to see our houses as shelter, not as instruments for financial gain. If there are still people out there who don't understand that, I promise you, you will sometime during the process which will take prices down that 80% or 90%. There is no credit available. That is what a credit crisis means to us all. And our governments cannot create credit out of nothing. And even if they could, who would want to borrow? The millions of unemployed foreclosed upon 21st century Tom Joads?

I have been on record for a long time saying that all basic human needs must of necessity be provided for all citizens by our communities and societies. When I read that a 93-year old man freezes to death in Minnesota because his heating was cut off, I'd say we're doing very poorly in the regard. Much of our food comes from markets that won't be able to reach us anymore in the near future, our water treatment systems depend on heavy energy use we will soon have a very hard time paying for, and the main question that seems to occupy the mind of the winner of the non-existent but much publicized Economics Nobel is how we will divide the offerings of the "upside return". You are a blind old man. You may be wise, but you cannot see.

In the face of so many wasted neurons, please forgive me my moments of despair. The question is, or if you will should be: how do we keep people from freezing to death, from starving, from cholera epidemics once water systems fail. We won't do it by indebting our children and grandchildren in doomed efforts to keep a bankrupt society rolling, while we recite fairy tales of future profits from bets on horses that have long since left their stables, disppeared beyond our receding horizons, and never been heard from since. We will only maximize the suffering this way.

Countries struggling to secure credit have resorted to barter and secretive government-to-government deals to buy food, with some contracts worth hundreds of millions of dollars. In a striking example of how the global financial crisis and high food prices have strained the finances of poor and middle-income nations, countries including Russia, Malaysia, Vietnam and Morocco say they have signed or are discussing inter-government and barter deals to import commodities from rice to vegetable oil. The revival of these trade practices, used rarely in the last 20 years and usually by nations subject to international embargoes and the old communist bloc, is a result of the countries’ failure to secure trade financing as bank lending has dried up.

The countries have not disclosed the value of any deals, and some have refused even to confirm their existence. Officials estimated that they ranged from $5m for smaller contracts to more than $500m for the biggest. Josette Sheeran, head of the United Nations’ World Food Programme, said senior government officials, including heads of state, had told the WFP they were facing “difficulties” obtaining credit to purchase food. “This could be a big problem,” she told the Financial Times. Last week, Malaysia’s commodities minister, Datuk Peter Chin Fah Kui, said Kuala Lumpur had already signed a barter deal swapping palm oil for fertilizer and machinery with North Korea, Cuba and Russia. He said Malaysia was talking to Morocco, Jordan, Syria and Iran about other barter deals.

“[Bartering] could be used for contracts with other countries that do not have the cash,” Mr Chin told the local press. “We can set the conditions for them to supply us with the raw materials that we need.” Thailand, the world’s largest exporter of rice, is discussing barter deals with Middle Eastern countries, including Iran. The Philippines, the world’s largest importer of rice, has secured rice needs for this year through a diplomatic agreement with Hanoi. The countries’ struggle to obtain credit to import food is boosting the price of domestic crops. Ms Sheeran said that prices of crops in some African countries were rising sharply even as international food commodities prices had fallen from last summer. The move to barter shows the global food crisis that started last year is far from over.

The global downturn could result in tens of thousands of unnecessary deaths if countries do not protect programmes targeted at the poor, a senior World Bank official warned on Monday. Julian Schweitzer, director of health, nutrition and population at the bank, told a conference that donors and developing countries should support initiatives including direct cash payments to the poor in order to reduce the likely severe impact on health services. His comments came during an Action for Global Health meeting of non-profit organisations in London convened to discuss the probable slowdown in donor support for health programmes after a sharp rise since the start of the decade.

Mr Schweitzer cited a bank study published in 2007 estimating that there had been more than 1million excess infant deaths during previous downturns during 1980-2004, with girls suffering more than boys. He also warned that the impact of the current crisis was likely to be more severe, given that its origins were in the developed world rather than previous ones in developing nations. He urged rich countries to continue increasing foreign aid, singling out for implicit criticism Italy for cutting its contribution. He stressed the importance of relating “success stories” to maintain discussion of aid during the crisis. While governments often resist job reductions among healthcare workers, he said that essential drugs and other imported medical supplies risked drying up in many poorer countries as they became much more expensive following the devaluation of local currencies.

As the World Health Organisation leads a “health for wealth” session at the World Economic Forum in Davos designed to persuade policymakers to maintain funding, a number of organisations are already beginning to feel the impact of the crisis in declining support. “Anyone who thinks there will be a major increase in bilateral funding over the next two years is very, very optimistic,” said Mr Schweitzer. The United Nations-backed Global Fund to Fight Aids, TB and Malaria has held off a new round of fund-raising, and many individual organisations are beginning to feel support from donors drying up and bracing themselves for cuts and ways to demonstrate they are spending money more effectively.

Donor governments, including Germany, Italy and Ireland, have already begun to pull back on international development assistance in discussions with international agencies and non-profit organisations. In the US, many observers believe it is almost inevitable that the current budget crunch will result in a reduction in the $50bn five-year pledge agreed in 2008 by legislators to renew outgoing US president George W. Bush’s drive against Aids, malaria and tropical diseases. Even for the UK, which has so far pledged to maintain its levels of development aid, the falling value of the pound against the dollar means its contribution in real terms is set to fall significantly.

Home prices in 20 U.S. cities declined 18.2 percent in November from a year earlier, the fastest drop on record, as foreclosures climbed and sales sank. The decrease in the S&P/Case-Shiller index was in line with forecasts and followed an 18.1 percent drop in October. The gauge started falling in January 2007, and year-over-year records began in 2001. Record foreclosures have contributed to more than $1 trillion in losses worldwide that have prompted banks to shut off access to credit. While plunging values have made homes more affordable, they have also hurt household wealth, contributing to a slump in spending that’s likely to continue for the first half of the year.

"The housing market has not yet reached its bottom," Neal Soss, chief economist at Credit Suisse Holdings in New York, said in an interview on Bloomberg Television. "People have to be in a position where they are not afraid of their most significant asset." Economists forecast the 20-city index would fall 18.4 percent from a year earlier, according to the median of 27 estimates in a Bloomberg News survey. Projections ranged from declines of 17.4 percent to 20 percent. Compared with a year earlier, all areas in the 20-city survey showed a decrease in prices in November, led by a 33 percent drop in Phoenix and a 32 percent decline in Las Vegas.

"The freefall in residential real estate continued through November," David Blitzer, chairman of the index committee at S&P, said in a statement. "Overall, more than half of the metro areas had record annual declines." Consumer confidence this month probably held near a record low as Americans fretted about paying their mortgages and keeping their jobs, economists forecast the Conference Board’s sentiment index will show today at 10 a.m. Robert Shiller, chief economist at MacroMarkets LLC and a professor at Yale University, and Karl Case, an economics professor at Wellesley College, created the home-price index based on research from the 1980s.

The 20-city index is down 25 percent from its 2006 peak. Eleven of the 20 metropolitan areas showed record declines in the year ended in November, and eight showed the biggest month-to- month decrease on record. Home prices decreased 2.2 in November from the prior month, matching the October decrease, the report showed. The figures aren’t adjusted for seasonal effects so economists prefer to focus on year-over-year changes instead of month-to-month. Phoenix and Las Vegas also showed the biggest one-month declines.

Other housing reports have shown property values continue to weaken as foreclosures climb. The median sales price of existing homes fell 15.3 percent in December from a year earlier, compared with a 13.6 percent annual decline the prior month, the National Association of Realtors said yesterday. Sales of existing homes, which make up about 90 percent of the market, gained 6.5 percent in December from a decade low the prior month, the Realtors group said yesterday. For all of 2008, existing home sales fell 13.1 percent.

U.S. foreclosure filings jumped 81 percent last year as more than 2.3 million properties got a default or auction notice, or were seized by lenders, according to RealtyTrac Inc., an Irvine, California-based seller of default data. President Barack Obama has pledged to unveil programs to stem foreclosures and boost housing as he battles the longest recession in a quarter century. The president will also use the second $350 billion outlay from last year’s financial rescue plan to help stem foreclosures, White House press secretary Robert Gibbs said yesterday.

Housing starts are down 75 percent from their January 2006 peak. Declining construction has hurt economic growth for the last three years and is likely to weigh further on the economy as the recession extends into 2009. Builders, banks, retailers and manufacturers are all feeling the pinch. Caterpillar Inc., the world’s biggest maker of construction equipment, yesterday announced it was cutting 20,000 jobs as the worldwide building slump hurt sales. "We’re in the midst of a downward spiral and the momentum is building," Chief Executive Officer Stuart Miller said on a conference call.

As housing and real estate continue to decline, the questions arise: how low will it go? When will it hit bottom? There are powerful reasons to suspect the answers are: much lower, and not for quite some time. I have been addressing "how low can housing go?" since 2006, as these charts illustrate:

I think the last chart has proven remarkably prescient to date, with the collapse of Lehman Brothers providing the extrernal "shock" (never mind it was entirely predictable, it was a "shock" to the MSM). We are now approaching "the last gasp of the bottom fishers" which I now expect to last into 2010--that is, everyone has accepted that 2009 will be a year of deep recession, so they're busy buying for the "upturn" which the MSM is predicting will begin in 2010.

The MSM will be as accurate in that prediction as they were about Lehman Brothers or the housing bubble imploding. Bottom-fishers who snap up "bargains" in 2009 (as noted above, houses which once sold for $470,000 can be had for $200,000--such a deal!) will be finding in 2010 that market rents (assuming they're even able to rent their bargains without spending tens of thousands of dollars in repairs) are not even paying their costs of ownership, and so they'll be trying to dump their "bargains" purchased for $200K for $150,000--and finding few buyers.

Even my wife is skeptical of my longstanding calls for housing in once-hot locales to bottom at 10% - 20% of their bubble-era valuations. Thus on the chart above I indicate that a house which sold for $470,000 at the bubble top may well fetch a mere $70,000 at the final saucer-shaped bottom. (That is, the bottom will not be marked by some sharp capitulation as occurs in the stock market; the bottom will last for months or even years, and the recovery will be akin to watching paint dry.) I reiterate that this is a prediction based in history--which means that it may not happen, but that the possibility falls solidly in the realm of historic fact. In the depths of the Great Depression, highrise buildings in Manhattan sold for about the value of the elevators: roughly 10% of the cost of the entire building's construction.

In areas with decreasing economic opportunities such as greater Detroit, houses are already sold for $1, and many are listed for less than $10,000. Prices in Manhattan, Honolulu and San Francisco have softened, but watch what happens when global tourism dries up and blows away to a mere 5% of its previous traffic, and what happens when the financial-services sector of the economy shrivels from 18% of GDP down to 2 or 3%. Then there's the little problem of assessing the risk of buying real estate. Who's to say that this "bargain price" may not fall further? Let's say the house which once sold for $470,000 is now available for $200,000 for 25% down ($50,000). What if that "bargain property" should fall 20% further in value down to $160,000? Not much of a drop, you say, in light of how far it's already declined?

Perhaps--but the bottom-fisher just lost their entire down payment, for after losing $40,000 as the price dropped, the remaining $10K is eaten up by the transaction costs of selling (6% of $160,000 is $9,600.) But won't the bottom-fishers be rewarded as valuations climb after the recession? As noted here many times, let's start with the fact that according to the Census Bureau, some 18 million dwellings in the U.S. are vacant--and given the homes under construction and rising foreclosures, we can safely round that up to 20 million. That's a lot of supply for an uncertain future demand.

For the 76-million strong Baby Boom is aging and will be seeking to sell their primary residence in order to enter retirement/care homes or smaller dwellings closer to healthcare and other services. These demographic forces are at work regardless of the length or depth of the recession/depression. As the economy shrinks, as lending tightens, as deflation eats away at assets and as stock and bond declines wipe out pensions, then we have to ask: how long might this real estate recession last? If the answer might be 10-12 more years, then the natural question becomes: why buy now and have your capital trapped for a decade or longer?

Housing did take a sharp fall in Q3 2008 after an illusory period of stabilization in many markets, and so the capital trap has shut on everyone who "bought the dip." So when does housing finally bottom? In my oft-stated view, two conditions control that timing:

Housing must be widely viewed as shelter, and be totally discredited as a speculative vehicle for wealth creation.

Market rents must provide a buyer/investor with an absolute cash-accounting positive return, that is, after all repairs have been made and all costs of ownership have been tallied without tax-related legerdemain. This calculation must also include vacancies, i.e. the reality that the dwelling may not be generating income 365 days a year.

When these two conditions have been met, then we'll be somewhere in that multi-year saucer-shaped bottom in housing/real estate.

Fannie Mae, the largest source of home-loan money in the U.S., said it will need to tap as much as $16 billion in emergency funds from the U.S. Treasury Department to stay afloat as deterioration in the housing market persists. Fannie’s planned request, announced today, follows Freddie Mac, which said Jan. 23 that it will need as much as $35 billion more in federal aid. Unprecedented mortgage losses drove the net worth of both companies below zero last quarter, they said in separate securities filings.

This will be Washington-based Fannie’s first draw on a $200 billion emergency fund set up by Treasury in September to keep the government-sponsored enterprises solvent. Fannie said losses on mortgage loans and a decline in the market value of its assets accounted for the shortfall in the fourth quarter. Fannie’s Treasury request was "much worse" than expected, said Rajiv Setia, a fixed-income strategist at Barclays Capital in New York. Setia estimates taxpayers will have to shell out at least $50 billion for Fannie and $70 billion for Freddie this year. One or both, especially Freddie, may exceed the Treasury’s backstop this year, he said.

The requests for funds comes as the Treasury faces increasing demands from U.S. financial companies such as Bank of America and Citigroup Inc., which are coping with the fallout from a slumping housing market and a deep recession that’s driving foreclosures to record levels. Freddie and Fannie are the largest sources of mortgage money in the U.S., owning or guaranteeing a combined $5.2 trillion of the $12 trillion home-loan market. McLean, Virginia-based Freddie, which received $13.8 billion in aid in November, will be using about half of its $100 billion lifeline from Treasury once it receives its second capital injection.

"Hopefully policymakers are proactive in upping the $100 billion backstop," Setia said. "You don’t want them to get to those levels and have to revisit the issue." The companies have posted five consecutive quarters of losses totaling $68.4 billion combined. The Federal Housing Finance Administration seized their operations in September amid concern from regulators that the two may fail in the worst housing slump since the Great Depression. Fannie has previously said that $100 billion may not be enough to keep it afloat. Treasury agreed to pump money into the companies if the value of their assets drops below what they owe on their obligations. Fannie’s $3.1 trillion total book of business was worth $9.4 billion at the end of the third quarter. Fannie’s preliminary request was $11 billion to $16 billion.

Dividends are being cut at the fastest pace in at least 50 years, and many of the reductions are coming from U.S. companies investors have been relying on to provide income during the recession. Already this year, seven companies in the Standard & Poor's 500 index have decreased their dividends, removing some $12 billion from shareholders' pockets in the coming months. On Monday, Pfizer became the latest blue-chip company to do so. These cuts serve up another hit to shareholders who have already been battered by the steep declines in the stock market. That is especially true of retirees, who tend to be attracted to so-called "widows and orphans" stocks that provide them with a steady cash flow. If the trend continues, this will be the worst year for dividend cuts since 1958, when annual payments fell by 8.4 percent, according to new research from S&P.

"It is easy to say this is going to be the worst in 50 years, but the bigger question is whether it is going to be much worse than that," said Howard Silverblatt, senior index analyst at S&P. That's not to say that companies shouldn't cut their dividends if they can't afford to pay them. The financial industry, for example, has been most active in slashing payouts because it had to -- companies need to cut costs and those that have gotten federal aid also have faced pressure from the U.S. government to reduce their dividends. Of the seven companies that have said they will cut dividends in 2009, six are in the financial industry and all reduced their payouts by at least 50 percent, according to the S&P research.

The largest decrease has come from Bank of America, which said earlier this month it would slash its dividend from $1.28 a share annually down to 4 cents a share. That wiped out $6.2 billion in yearly payouts to investors. The Charlotte, N.C.-based company disclosed its dividend cut as part of a deal with the government to inject another $20 billion into the ailing bank to help it absorb losses from its recent acquisition of investment bank Merrill Lynch. In total, Bank of America has received $45 billion in federal aid. Only one financial company, Hudson City Bancorp Inc., has raised its dividend this year, from an annual rate of 52 cents to 56 cents. Ten other companies in industries retailing to energy have raised their payouts, too, but all by a tiny margin. In total, those increases equal about $200 million annually.

Companies in other industries haven't been able to escape the financial and economic malaise either. Their profitability and cash flows are under pressure, and they look to preserve cash by slashing their dividends. "Over the longer-term, cutting a dividend might actually been seen as something positive" for the health of the company, said Paul Davis, a portfolio manager at Charles Schwab & Co. Inc. But dividend cuts can surprise income-seeking investors who have increasingly turned to higher-yielding shares in sectors presumed to be safer than financials. Pfizer's announcement on Monday that it would knock its annual dividend down to 64 cents a share from $1.28 a share caught many investors off guard, said Michael Krensavage, who runs Krensavage Asset Management and owns Pfizer shares.

That came as part of the news Pfizer was acquiring rival drugmaker Wyeth for $68 billion in a cash-and-stock deal that will solidify Pfizer as the world's largest pharmaceutical company. Pfizer had long been a reliable dividend payer, raising its dividend annually for more than 40 years until December when it announced its quarterly payment would be flat when it made its next quarterly payout. But it still paid out the third-most in annual dividends among S&P 500 companies, trailing just General Electric and AT&T Inc. Pfizer will drop to No. 7 when the Wyeth deal closes, with total payouts of about $5 billion, according to S&P's Silverblatt. Pfizer chief financial officer Frank D'Amelio said during a conference call with analysts that the dividend cut was done in part to "redeploy capital" and assist in financing the transaction with Wyeth.

Dividend-seeking investors may want to take note of Pfizer's action when analyzing their own income-generating portfolios, said Josh Peters, editor of Morningstar DividendInvestor. One rule of thumb that Peters employs is to look at the dividend yield -- the annual dividend per share divided by the price per share -- to see how it ranks with its sector's peers. That shows how much a company pays out each year in dividends relative to its share price. Pfizer's nearly 8 percent yield had put it well ahead of its rivals including Johnson & Johnson and Abbott Laboratories, which had dividend yields closer to about 3 percent -- right about where Pfizer will be going forward. Silverblatt has been looking for companies with estimates of earnings per share for 2009 that won't cover what they've promised in dividends. Of the companies in the S&P 500 that pay dividends, some 16 percent of them are what Silverblatt deems as "under stress."

The Federal Reserve bought $1.7 billion of Fannie Mae, Freddie Mac and Federal Home Loan Bank notes on Tuesday, for a total of nearly $25 billion since the purchase program began in December. The Fed has said it would buy up to $100 billion of these securities, as well as up to $500 billion of mortgage bonds issued by Fannie, Freddie and Ginnie Mae to help cut mortgage rates and revive U.S. housing. With this purchase, the ninth since the program kicked off on Dec. 5, the Fed is a quarter of the way toward its agency note purchase goal. The Fed has also said it stands ready to increase the amount of purchases if necessary. Dealers submitted $3.395 billion for consideration in the latest Fed purchase, the New York Fed said on its website. The Fed bought agency debt securities maturing from February 2011 through December 2012 in an outright coupon purchase, the bank said.

So what does the Federal Reserve do to stimulate a moribund economy when it already has pushed its key short-term interest rate virtually to zero?That’s the central question facing Fed policy-makers as they gather today and Wednesday to ponder their next steps through the economic quagmire. One answer to that question: Go shopping. The Fed’s balance sheet in recent months has more than doubled in size — to more than $2 trillion — as it has purchased commercial paper and the like. And its balance sheet may triple in size as it moves more aggressively into buying mortgage-backed securities in an effort to push mortgage rates lower. More on that in a moment.

The Fed meeting comes just days before the Commerce Department on Friday releases its first estimate of fourth-quarter gross domestic product. Brace yourself for an eye-popping number. On average, economists are estimating that our economy contracted by at least a 5 percent annual rate during the fourth quarter. By way of perspective, the economy has contracted by that much in just six quarters since the government started tracking quarterly data in 1947. The worst post-World War II quarter occurred in early 1958, when the economy dropped at a staggering 10.4 percent annual rate. The economy contracted at a 7.8 percent annual rate in the second quarter of 1980, and at a 6.4 percent annual rate in the first quarter of 1982. If this week’s report resembles those numbers, we will begin debating whether this recession deserves a special moniker. How about the Great Recession?

By one measure, we’re well on our way to setting a modern-day record for duration. Since World War II, we’ve posted two recessions lasting as long as 16 months, according to the National Bureau of Economic Research. The first lasted from November 1973 until March 1975. The second lasted from July 1981 until November 1982. Given that the bureau has determined that the current recession began in December 2007, we’re on track to set a modern-day duration record in May. Despite all the talk of fiscal stimulus and the monetary steps the Fed has taken to date, it’s unlikely we’ll be out of this recession within four months. One can hope, of course. In the meantime, we can take some comfort in the fact that this recession hasn’t yet challenged records set before World War II. The whopper in popular memory, of course, remains the 43-month contraction stretching from August 1929 to March 1933, which heralded the Great Depression.

Less remembered, though, is the so-called Long Depression, a contraction which stretched a staggering 65 months from October 1873 to March 1879. All told, there were 13 contractions lasting more than 16 months between 1857 and 1933. There is a message in all this deep economic history. Over time, recessions in general have become shorter and less harsh largely because of the increased sophistication of both business managers and government policy-makers. Improvement in everything from inventory management to monetary policy has helped us through the hard times better than in the old days. Of course, now we’re facing a fresh and potentially precedent-setting test of that theory. Despite widespread support for a massive fiscal stimulus plan — based on the notion that someone must provide demand when consumers and business are pulling back — my sense is that the Fed remains a key player. Although stimulus spending is welcome, it will not enter the economic system nearly so fast or effectively as we would wish. Meanwhile, our central problem remains the housing market and the often toxic securities backed by those assets.

Seventeen months after seizing up at the onset of the credit crisis, the $1.69 trillion commercial paper market may be the first to cut its reliance on federal bailout programs. About $245 billion of 90-day commercial paper that companies sold to the Federal Reserve starting in October will mature this week and next, central bank data show. As much as $50 billion to $70 billion of the debt may be rolled over and bought by investors, according to Barclays Capital in New York. The market’s ability to absorb the maturing debt may build confidence that U.S. companies are able to fund themselves without government support, said Deborah Cunningham, chief investment officer for taxable money markets at Federated Investors Inc. Investors, betting the commercial paper market has stabilized, pushed interest rates to record lows this month and bought the most 90-day debt since September, Fed data show. The debt rollover represents “a test of how well the market can sustain itself,” said Cunningham, who is buying commercial paper for Pittsburgh-based Federated, which oversees $288 billion in money-market assets. “And I think it will pass the test.”

Rates on AA ranked financial commercial paper due in 90 days fell to a record low of 0.28 percent on Jan. 8, or 21 basis points more than the U.S. borrowing rate, Fed data show. They have since jumped to 2.15 percent, or 201 basis points more than the government yield on 90-day Treasury bills, as investors prepared to absorb at least $486 billion of overall paper coming due this week, according to Fed data. The gap peaked at 374 basis points on Oct. 15. The Fed data also reflect sales to the CPFF. The Fed demands 2.24 percent to own unsecured debt, including a one percentage point fee, under its Commercial Paper Funding Facility. Companies use commercial paper, which typically matures in nine months or less, to fund everyday expenses such as payroll and rent. Their need for the financing may wane during the U.S. recession, which started in December 2007. The economy contracted at a 5.5 percent annual rate from October through December, the biggest drop since 1982, according to the median estimate in a Bloomberg News survey before Commerce Department figures due Jan. 30.

Businesses and consumers haven’t benefited as much as banks from the more than $8.5 trillion the government has committed to shoring up the financial system. The difference between yields on 30-year mortgages and 10-year Treasury notes is 2.5 percentage points, compared with an average of 1.7 points during the past two decades, data compiled by Freddie Mac and Bloomberg show. Spreads on investment-grade corporate bonds averaged a near- record 553 basis points as of yesterday, more than double the pre-crisis high of 272 basis points of 2002, according to Merrill Lynch & Co.’s U.S. Corporate Master index. The market for commercial paper backed by assets such as auto loans and credit cards was the first to seize up. It fell 37 percent over five months to $772.8 billion, from its peak in August 2007 of $1.22 trillion, as defaults on subprime home loans began to soar. After Lehman Brothers Holdings Inc. filed for bankruptcy on Sept. 15, the broader commercial paper market froze. The next day, the flagship $62.6 billion money-market fund of Reserve Management Co. became only the second of its kind to break the buck, or fall below the $1-a-share price paid by investors, triggering a run that helped freeze global credit markets and drive up borrowing costs.

Returns on money-market funds have dropped 62 percent since then, according to the Crane 100 Money Fund Index, which tracks the average annualized yield of the top 100 money funds during the previous seven days. The commercial paper market slumped 20 percent over six weeks as money-market investors fled for safer assets such as Treasuries. Prime money-market funds’ holdings of first-tier paper, rated at least P-1 by Moody’s Investors Service and A-1 by Standard & Poor’s, fell by 33 percent from Sept. 9 to Oct. 7, according to iMoneyNet of Westborough, Massachusetts. On Oct. 27, the Fed set up the CPFF, complementing a separate program for asset-backed debt that began in September. They were intended to ensure companies had access to short-term credit and to ease redemption concerns at money-market funds. The amount outstanding under the asset-backed program peaked at $152.1 billion on Oct. 1, before plunging to a low of $14.8 billion last week as redemption concerns subsided.

The Fed set up another program, the Money Market Investor Funding Facility, to provide liquidity to money-market investors. The facility, which buys commercial paper due in 90 days or less, hasn’t been used since it began operating on Nov. 24. About $220 billion to $230 billion of 90-day commercial paper sold to the Fed above market rates in October through the CPFF matures this week, said Garret Sloan, a short-term debt analyst at Wachovia Corp. in Charlotte, North Carolina. That’s as much as 66 percent of the $350 billion in debt that the CPFF owns. The Fed has purchased about one-fifth of the commercial paper market through the CPFF. The Fed bought $145.7 billion of the debt in the program’s first three days. GE Capital Corp., a unit of General Electric Co. of Fairfield, Connecticut, and New York-based credit-card issuer American Express Co. were among the first companies to sell commercial paper to the Fed, Bloomberg data show. GE Capital was the biggest borrower in the commercial paper market in 2008, according to October data from JPMorgan Chase & Co. GE said Jan. 23 it hasn’t used the CPFF since November.

Also signing up to sell to the Fed were Morgan Stanley, the second-biggest U.S. securities firm before converting to a bank last year; Hewlett-Packard Co. of Palo Alto, California, the world’s largest personal-computer and printer maker; and American International Group Inc., the insurer rescued by the U.S. in September. Morgan Stanley and AIG are based in New York. Companies aren’t required to disclose how much debt they’ve sold through the Fed facility. Fed purchases declined in the first two weeks of the year as investors picked up the slack, reducing government buying to $179 million. First-tier commercial paper assets in prime money-market funds increased 26 percent to $790.6 billion as of Jan. 13, iMoneyNet data show. Purchases jumped last week to $15.7 billion, the most since November, as some companies remained unable to sell 90-day commercial paper to investors at rates below the cost of issuing to the Fed. Joseph Abate, a money-market analyst at Barclays in New York, said the increase signaled the market may need more government support than he had expected. Prime money fund commercial-paper assets fell 2.46 percent last week.

Sales of commercial paper due in more than 80 days jumped to $39 billion yesterday, including CPFF issuance, Fed data show. About $24 billion of that was backed by assets and $5.2 billion was issued by first-tier financial companies with AA ratings. The Fed probably will have to extend the CPFF past its scheduled April 30 expiration to avoid “burning its credibility” if it pulls back and the market then collapses, said Adolfo Laurenti, a senior economist at Mesirow Financial Inc. in Chicago. The “market consensus” is that the CPFF will continue past April, Sloan said in a telephone interview. “And I think this week is going to be a very big factor in whether that happens.” Policy makers also may force companies to wean themselves from federal help by making it “increasingly expensive” to use the CPFF, said Louis Crandall, the chief economist at Jersey City, New Jersey-based Wrightson ICAP, a research unit of ICAP Plc, the world’s largest inter-dealer broker. The Fed demands 1.24 percent to own unsecured debt, plus a 1 percentage point fee. The rate for paper backed by assets was 3.24 percent. At current yields, selling commercial paper to the Fed may cost a typical borrower almost three percentage points more than market rates, indicating most companies are able to find non- government buyers for their debt.

Companies may have been refinancing CPFF debt for the past few weeks to avoid being forced to handle all of it at maturity, Abate said. Issuance of commercial paper due in more than 80 days has accelerated, with sales to market investors totaling $62.4 billion in the week ended Jan. 14, the most in almost five months, Fed data show. Assets in money-market funds reached a record high of $3.92 trillion on Jan. 14, according to the Investment Company Institute. Money market funds are sitting on this pile of cash with few alternatives, Abate said. Yields on AA ranked financial paper were 3.25 percent on Oct. 26, or 36 basis points more than the initial CPFF rate, including the unsecured credit surcharge, which is waived for financial borrowers that issue commercial paper with U.S. backing, at an extra 50 basis points. A basis point is 0.01 percentage point. AA rated 90-day asset-backed commercial paper yielded a low of 0.28 percent on Jan. 9, or 290 basis points less than the CPFF charges to own the debt. Meanwhile, rates on second-tier 90-day commercial paper ranked one grade lower and excluded from the CPFF have plunged about 5 percentage points in the past month, to a five-year low of 1.16 percent on Jan. 20. “At this point, if you have to issue into the CPFF, it is clearly punitive to the issuer relative to market levels,” Sloan said in an e-mail. “There will be some widening in spreads as the market tries to absorb the roll, but it shouldn’t climb back to CPFF funding levels.”

Turning federal policy around on a dime is tricky. But it is what President Barack Obama and his economic team will have to know when and how to do. The policies needed in the short term to avert further collapse of our financial system amid a global recession are the reverse of what is required in the long term to restore healthy growth in the United States. To balance the needs of the immediate against the demands of the future, the administration will have to focus on at least six tipping points: - At the moment, the Fed's focus is rightly on avoiding price deflation. Deflation would push consumers to hold off on spending as they wait for lower prices down the road, prolonging the recession. Deflation would also increase the already heavy burden of debt carried by both the government and the private sector.

The threat of deflation is real. The Fed has worked aggressively to make sure money and credit are available. Yet the U.S. price level (a measure of overall prices) was almost certainly lower in 2008 than it was in 2007. If so, this will be the first such decline since 1955. The yields on TIPS (inflation-protected Treasury securities) are currently higher than on comparable securities without such protection, reflecting expectations of continuing price declines. But once the world's economies are growing again, the Fed will have to contain the inflationary pressures it is now helping to generate. It will have to know when to step off the accelerator.

The recent financial bailouts have helped prevent a near-total freeze in private lending. But in the long run, the government will have to mop up the liquidity those bailouts have provided by selling off the assets it is buying up. This sell-off will be difficult and contentious. It will be necessary, however, because the amount of liquidity central banks are now creating may turn out to be excessive and damaging to the world economy.

Economic recovery can't begin until consumer spending picks up significantly -- as any retailer will testify. Yet to restore growth over the long term, Americans will need to increase their personal savings rate and not continue to rely on foreign loans to underwrite our economy. For years, the savings rate in the U.S. has hovered near zero.

The contradiction between spending to grow the economy and saving to help stabilize economic growth is also something the government needs to reconcile. Added together, the Troubled Asset Relief Program and the proposed economic stimulus package account for about $1.5 trillion added to the government deficit. This is unsustainable and will eventually harm the national economy.But halting stimulus projects once recovery is well underway will be politically difficult, if not impossible. Mr. Obama recognizes the challenge. He recently told the Washington Post that his administration will tackle entitlement reform and long-term budget deficits soon after it jump-starts job growth and the stock market.

In the short run, we need to maintain low interest rates by financing federal spending with foreign money, mainly through purchases of U.S. Treasury securities, but also with, often controversial, private investments. In the long term, this cannot last. Americans are right to be wary of relying on financing from China, Saudi Arabia and other countries. We can't count on them to have our national interests at heart and, in any case, they are starting to show a greater interest in investing in their own economies instead of ours, as we urged them to do.

Finally, the steps needed to shore up the financial industry in the short run will probably have to be undone in the interest of long-term economic growth. At the moment, large financial firms are being gobbled up by even larger financial firms. This consolidation has been welcomed and even actively encouraged by the government as an alternative to allowing a further weakening of the stability of our financial system.

But the result will be a more consolidated financial services industry, which will both lessen competition and create more financial institutions that will be deemed too big to fail. These outcomes threaten to make life more difficult for policy makers going forward, as they attempt to foster the creation of a more robust financial industry. Mr. Obama and his economic team have an unenviable task. They have to have impeccable timing in reviving the economy and then, quickly, shift from the economic accelerator to the brakes in the months and years ahead. There are a lot of curves in the road that will put the new administration to the test.

When Federal Reserve policymakers begin a two-day meeting today, they will be starting a new era in American monetary policy. Normally at meetings of the Federal Open Market Committee, the big announcement at the end is whether the central bank has decided to raise short term interest rates or lower them. But the Fed has pushed the federal funds rate, a bank lending rate it controls, effectively to zero, and indicated that it will likely leave it there for some time. That has exhausted the central bank's primary policymaking tool, meaning its leaders will use less conventional methods to bolster the rapidly worsening economy. "They're in uncharted territory," said Diane Swonk, chief economist at Mesirow Financial.

At its Dec. 16 policymaking meeting, the Fed laid out a new framework for its stewardship of the economy, suggesting the way it might try to stimulate growth. When the Fed releases its statement at 2:15 p.m. tomorrow, following the meeting's conclusion, Fed watchers will see what that means in practice. The Fed could expand a program to buy up mortgage-related securities, a plan that already has pushed mortgage rates down sharply. Under that program, announced just before Thanksgiving, the central bank has agreed to buy up to $100 billion of debt in housing finance companies Fannie Mae and Freddie Mac and $500 billion of mortgage-backed securities issued by the companies. As of last week, the Fed had only closed on about $30 billion of those purchases, yet even that was enough to push the average rate on a 30-year fixed-rate mortgage down to 5.1 percent last week, compared with 6.1 percent in November.

Fed leaders were surprised that the relatively small amount of purchases was enough to lower borrowing rates, which serve to stimulate the economy as homeowners refinance their mortgages to have more money to spend on other goods and more people buy homes to take advantage of the low rates. It also could expand a program, also announced in November and poised to begin in February, that would use $200 billion in Fed resources to support lending through credit cards or for car loans, student loans, and small business loans. "The Fed wants to bring down the rates facing households and firms," said Peter Hooper, chief economist at Deutsche Bank Securities. "This is the program that could have the most traction." On the other hand, Fed leaders may be reluctant to expand the consumer-lending program before it has begun functioning. The transition to the Obama administration may also make it harder to quickly change the program, which is a joint effort with the Treasury Department.

A third option the Fed may move on this week would be to start buying long-term Treasury bonds to try to push down interest rates on all kinds of longer-term borrowing. Normally the Fed manipulates interest rates only by buying up short-term Treasury bills. But if it bought five- or 10-year bonds, it could help lower borrowing costs for companies and individuals that borrow money for long periods of time. There may be reason for Fed officials to be cautious about buying long-term debt, however. Yields on such Treasury bonds are already near historic lows, with the government able to borrow money for 10 years at 2.6 percent. Moreover, with credit markets not working normally, there can be little certainty that pushing those rates even lower would result in savings for private borrowers. While the central bank won't necessarily make announcements in all these areas this week, analysts said, all are options in the months ahead. Moreover, the Fed can impact markets merely by discussing its intentions to undertake new lending, even in advance of it happening. "Do you want the policy initiatives you're taking to be more targeted at unraveling the credit market seizures or better for overall rates?" Swonk asked. "The answer is the Fed has to do a little bit of everything."

Someone returning to Earth from a yearlong sojourn in outer space could be excused for feeling disoriented. After all, when said space traveler departed our fair planet, the U.S. economy was buckling under the weight of the burst housing bubble. The blame game was in full swing, with the villains ranging from Alan Greenspan and his easy money policies to consumers borrowing and spending beyond their means to financial institutions enabling profligate spending to a misallocation of capital to housing. Fast forward one year, the crisis is still going strong, the villains are still under attack, yet something curious has happened: The policies and actions responsible for the economy’s illness are now being prescribed as cures. How can that be? It’s not just our space traveler who’s confused.

Let’s start with the Federal Reserve. In the beginning, there was a boom in technology and Internet stocks followed by a predictable bust. Easy money, which had inflated the stock market bubble, came to the rescue, in the process fomenting another bubble of greater magnitude. Then-Fed Chairman Greenspan let the benchmark overnight interest rate overstay its welcome at 1 percent, raising it so slowly that anyone with or without a good credit rating had time to get in on the housing boom. The bubble burst with a ferocity that surprised even the most ardent bears. The price of overnight credit is now 0 percent to 0.25 percent, and the quantity of credit (the Fed’s balance sheet) has more than doubled in the past year. If removing the monetary stimulus was tough back in 2004, 2005 and 2006, just imagine what it will take this time when the magnitude of the task will necessitate Fed action well before politicians think it’s feasible.

Now let’s move on to housing, an asset whose price had never declined on a nationwide basis since the Great Depression. At least until home prices started to roll over in 2006. During the height of the condo-flip frenzy, too much capital was being allocated to housing, a tax-advantaged, unproductive asset. And it was housing, the mortgages used to finance their purchase and the intertwined web of securitized loans that sent the economy into a tailspin. Now that we’re here, with more homes for sale than buyers at the current price, what’s the government’s solution? Why, make it easier -- and cheaper -- to buy homes. The Fed has embarked on a program to buy $500 billion of mortgage bonds in the first half of 2009 in an attempt to lower actual mortgage lending rates, which fell to an all-time low of 5 percent earlier this month. Rather than let the market “clear” -- or let prices seek their own level -- policy makers are stimulating artificial demand for housing to prevent prices from falling. Welcome back to square one.

Then there’s the over-indebted consumer. From 1952 to 1998, the U.S. household sector was a net supplier of funds to the rest of the economy, acquiring more financial assets than debt, according to Paul Kasriel, chief economist at the Northern Trust Corp. in Chicago. That changed in 1999, when the household sector’s “net acquisition of financial assets,” as it’s called in the Fed’s Flow of Funds Report, turned negative. Households were “net demanders of funds” until 2008, at which point the gap turned positive again, Kasriel says. “It wasn’t because they were acquiring more assets. It was because they couldn’t acquire as much debt.” Banks, burned by their former excesses, have shut the spigots so even good credits are having trouble getting loans. The government wants to ensure that consumers, whose spending accounts for about 70 percent of gross domestic product, can borrow and spend. This makes as little sense as using easy money and housing incentives to cure the effects of easy money and over-investment in housing.

“What policy makers on both sides of the Atlantic desire is to sustain household leverage and consumption at any price, when the only exit from the credit crisis involves a return to thrift by the overleveraged,” writes David Roche, president of Independent Strategy, a London consulting firm, in a Jan. 22 Wall Street Journal op-ed. “That cannot be achieved painlessly.” And yet the federal government is seeking ways to make mortgage and other credit cheaper and more readily available, going further into debt in the process. Institutions deemed too big to fail, such as mortgage-finance giants Fannie Mae and Freddie Mac, were recruited in that effort. (That was after they were told to curb the growth of their portfolios and before they became wards of the state.) These are short-sighted, short-term solutions being orchestrated at the expense of the economy’s long-term health, and I suspect most economists know it. (Politicians are a different story. Their knowledge of economics is generally confined to the area of trade: providing favors in return for campaign contributions.)

President Barack Obama’s crack economics team, including Larry Summers and Christina Romer, and Fed officials from Ben Bernanke on down have to understand that the problem of too much leverage can’t be fixed with more borrowing; that a misallocation of capital to housing can’t be cured with incentives to buy more homes; that consumers (and the nation) can’t spend their way to prosperity. At least I hope they do.

Ilargi: This is just plain funny: "Confidence among U.S. consumers unexpectedly fell in January...". Pray tell who did not expect that.

Confidence among U.S. consumers unexpectedly fell in January to a record low as job prospects remained dim. The Conference Board’s index of consumer confidence fell to 37.7, from a revised 38.6 in December, the New York-based private research group said today. Records began in 1967. Measures related to Americans’ views on incomes deteriorated. Caterpillar Inc. and Home Depot Inc. were among companies yesterday that said they will cut at least 74,000 workers from payrolls in coming months as sales drop and the recession deepens. President Barack Obama is trying to drum up support for quick passage of a stimulus plan that aims to create jobs, cut taxes and boost infrastructure spending.

"The consumer is being squeezed on so many sides," Douglas Smith, chief economist for the Americas at Standard Chartered Bank in New York, said in an interview with Bloomberg Television. "We’re going to have to see some turn in the labor market before we see much upside for consumer confidence." Economists forecast confidence would rise to 39, from a previously reported 38 for December, according to the median of 70 projections in a Bloomberg News survey. Estimates ranged from 35 to 45. An earlier report today showed home prices fell 18.2 percent in November from a year earlier, the biggest drop since records began in 2001, according to figures from S&P/Case- Shiller that cover 20 metropolitan areas. All the regions were down in the 12 months to November, led by a 33 percent slump in Phoenix and a 32 percent slide in Las Vegas.

Stocks surrendered earlier gains following the confidence report. The S&P 500 index was little changed at 836.27 at 10:11 a.m. in New York. The yield on the benchmark 10-year Treasury note fell to 2.61 percent from 2.64 percent late yesterday. Obama’s administration will direct more of the second half of a $700 billion financial rescue plan to open up credit for consumers and businesses and stem home foreclosures, his spokesman said yesterday. The president has asked his economic advisers for recommendations "specifically addressing home foreclosures, addressing financial stability in banks," White House Press Secretary Robert Gibbs said in a briefing. Meanwhile, lawmakers are debating an $825 billion package of tax cuts and new federal spending that the president hopes will be passed by the middle of next month.

A gauge of Americans’ view about the current economic environment dropped to 29.9 from 30.2. The Conference Board’s measure of the outlook for the next six months decreased to 43 from 44.2 in December. Today’s report showed the share of consumers who said their incomes were likely to increase over the next 6 months fell to 10 percent, the lowest on record. Perceptions on the current state of the job market climbed from December levels. A gauge of whether jobs are plentiful rose to 7.2 from 6.5, while the proportion of people who said jobs are hard to get decreased to 41.1 percent from 41.5 percent. "Consumers remain quite pessimistic about the state of the economy and about their earnings," Lynn Franco, director of the group’s consumer survey, said in a statement. "We can’t say that the worst of times are behind us." Caterpillar, the world’s largest maker of bulldozers and excavators, said yesterday it’s cutting 20,000 jobs and this year’s profit and sales will trail analysts’ estimates. The jobs include 12,000 employees, or 11 percent of the workforce, and 8,000 contractors, spokesman Jim Dugan said.

The U.S. recession, which began in December 2007, has so far cost 2.6 million jobs and is already the longest in a quarter century. The world’s largest economy probably contracted at a 5.5 percent annual pace from October through December, the biggest drop since 1982, according to the median estimate in a Bloomberg News survey ahead of Commerce Department figures due Jan. 30. Consumer spending, the largest part of the economy, is forecast to have dropped at a 3.5 percent pace last quarter after slumping at a 3.8 percent rate the previous three months. It would be the first time purchases declined more than 3 percent in consecutive quarters since records began in 1947. "We are in the midst of a global economic crisis," Wal-Mart Stores Inc.’s vice chairman and future chief executive officer, Mike Duke, told employees of the world’s largest retailer yesterday. Bentonville, Arkansas-based Wal-Mart said this month that fourth-quarter profit will miss its forecast and predicted revenue in January will be little changed.

Fourth-quarter profit at Harley-Davidson Inc., the biggest U.S. motorcycle maker, dropped 58 percent and the company said Jan. 23 it plans to cut 1,100 jobs and close three facilities. The company declined to project earnings for this year and said it’s reducing shipments by as much as 13 percent to prevent excess inventory. "We are certainly not immune to the current economic conditions," Chief Executive Officer Jim Ziemer said in a conference call Jan. 23. Retail sales this year may drop 0.5 percent, the first decline in at least 14 years, according to a forecast today by the National Retail Federation. The group made its first projection, which excludes autos, gas stations and restaurants, in 1995.

American Express reported a steep decline in earnings in the latest quarter, the company said Monday, citing slower consumer spending and rising delinquencies. The credit card giant said net income fell 79% to $172 million, or 15 cents a share, down from $831 million, or 72 cents a share, during the same period a year ago. Earnings for the New York City-based firm based on continuing operations were $238 million, or 21 cents a share. Analysts were expecting a profit of $235 million, or 22 cents a share, from continuing operations according to Thomson Reuters. Kenneth Chenault, AmEx's chairman and chief officer, cited a decline in overall cardmember spending as well as a rising number of late payments for the company's latest performance. "Our fourth quarter results reflect an operating environment that was among the harshest we have seen in decades," Chenault said in a statement. During the last three months of 2008, spending by cardholders fell 10% to $160.5 billion from $177.5 billion a year ago.

Adding to those woes, however, were U.S. consumers' and businesses' inability to keep up with their payments, as the rate at which loans turned bad nearly doubled during the quarter compared to the same period a year ago. Looking ahead to 2009, Chenault warned of weaker spending by its cardholders, adding that he expected delinquencies and uncollectible card balances would continue to climb. American Express investors however, seemed relatively encouraged about the news. AmEx stock, which finished 5% lower Monday, gained nearly 3% in after-hours trading. Analysts and rating agencies alike have wondered recently about AmEx's ability to withstand a deep and prolonged recession. Yet the latest results from AmEx, which has often been viewed as a proxy for credit card trends, suggest that the company has remained relatively secure despite tough economic conditions. But like other companies across the financial services sector, AmEx has taken bold steps to insulate itself from the fallout.

In late October, the company unveiled plans to cut 7,000 jobs, or approximately 10% of its workforce, adding that they expected the restructuring to generate a $1.8 billion cost benefit next year. Less than two weeks later, AmEx converted into a bank holding company. The move gave the company the ability to grow its deposit funding sources and also allowed it to access funds from the government's $700 billion bank bailout program. So far, AmEx has received $3.39 billion from the Treasury Department in exchange for preferred stock and warrants. Daniel Henry, the company's chief financial officer, told analysts during a conference call Monday evening that without government funds from the Troubled Asset Relief Program, or TARP, AmEx would have rein in credit extended to the consumers, small businesses and corporate customers its services. "TARP is enabling us to continue to provide credit to the marketplace," he said.

I once knew a senior European Union official – an Austrian – who argued to me that Greece had no place in the European Union. "Greece is not really culturally European, it’s part of the Middle East," he insisted. "Just listen to their music." To this the Greeks might legitimately reply: "Plato, Aristotle and (on the musical issue), Demis Roussos." But my Austrian friend’s views, while eccentric, touched on a real and sensitive issue within the Union: the fear that it is economically and politically divided between a northern hard core and a flaky southern fringe. This division became temporarily less important when the EU expanded to let in the countries of the former Soviet bloc – which then became the objects of the condescension formerly reserved for the likes of Greece and Portugal. But the EU’s north-south divide is now being brought back into focus by the global economic crisis.

The difference between the performance of the southern and northern European economies is now so acute that even pro-European think-tanks, such as the Centre for European Reform – in "The Euro at Ten: Is Its Future Secure?" by Simon Tilford – are speculating that Europe’s single currency, which currently includes 16 EU countries, could break up under the strain. It might seem a little cheeky for somebody writing from London to predict a crisis in the eurozone. The pound is plunging and some are comparing Britain’s plight to that of Iceland. But just because Britain is in trouble, it does not follow that the eurozone will fare well. On the contrary, it is heading into a deep recession with unemployment projected to rise to more than 10 per cent by 2010.

So what would a eurozone crisis look like? It would have three elements – financial, economic and political. The financial part would come when some of the weaker economies in the euro area found the markets were increasingly unwilling to finance their budget deficits. When euro-watchers hyperventilate over the "widening of spreads", this is what they are referring to – the fact that investors are increasingly demanding a higher rate of interest to buy Greek or Italian debt, as compared with debt from the more fiscally continent Germans. The crisis in the real economy would involve all the usual malign elements – recession, unemployment, bankruptcy. But there would also be a direct link to the financial problem. As the markets demanded higher interest rates from them, so countries such as Italy, Greece, Spain, Portugal and possibly Ireland would find managing their public finances ever harder. As Mr Tilford of the CER notes: "Membership of the euro insulates countries from the risk of a currency crisis, but currency risk can be replaced by credit risk." Behind this is the broader issue of loss of competitiveness on Europe’s southern fringe. Unable to devalue their currency, weaker economies can only restore competitiveness by cutting jobs and real wages. That is obviously a recipe for social unrest, which leads on to the political crisis.

Eurosceptics predict popular upheaval that will eventually force countries to leave the eurozone. Charles Dumas of London-based Lombard Street Research exults that: "Italy will have to leave the euro at some stage. The fundamental fallacy of Emu [economic and monetary union] is revealed by the crisis." Europhiles sigh that this is all absurd. A country that is in financial trouble would be crazy to leave the safe haven of the eurozone. Iceland, after all, is thinking of joining. In their view, the political consequences of the crisis will not be the disintegration of the eurozone or the EU – but ever deeper integration. Arch-federalists, such as Jean-Claude Juncker, the prime minister of Luxembourg, are floating the idea of the "mutualisation" of national debts within the eurozone. This would involve the wider euro area assuming the debts of the weaker nations. But, naturally, they would want something in return for this remarkable act of generosity. That something would be that weakling economies would submit to direction from the central authorities of the EU. Bureaucrats from Frankfurt or Brussels would draw up the budgets of Italy or Greece, not their finance ministers. So a crisis would lead not to the disintegration of the eurozone but to the much deeper political union that the euro arguably requires.

If euro membership forces southern European countries to make deep cuts in their budgets in the midst of a recession – at the behest either of the markets or of Brussels bureaucrats – that sounds like a recipe for a nationalist revolt. British eurosceptics assume that, under such circumstances, the Greeks would smash the crockery and march out of the eurozone. But that might be underestimating the deep commitment to European unity on the EU’s southern fringe. Countries such as Italy, Greece, Portugal and Spain are among the most ardently pro-European in the Union. Unlike the grumpy Brits they associate Brussels with good government – and the EU as a whole with prosperity and, even, democracy. Yet if the EU itself does not become the target of political unrest, some other part of the political system is bound to come under pressure. In recent months, there have been outbreaks of social unrest in several EU countries, from Latvia to Greece. As times get harder, southern Europeans could turn on Brussels. But it is equally possible that they will direct their fury at politicians closer to home. After all, they are easier to get at.

Along with skiing and partying into the night, Europe-bashing has long been a favorite sport, whenever the world's business and political elite gather here for their once-a-year winter schmoozefest.But this year many of the critics have fallen conspicuously silent. As top executives, government leaders and a wide range of experts gathered Tuesday for the weeklong World Economic Forum to talk about the challenges facing the battered global economy, the question many were asking was this: Could Europe's much-reviled social welfare system actually end up being the model for the 21st century world?

In the United States, the global stock market rout has wiped out trillions of dollars in retirement savings and rising unemployment is leaving more people without health insurance. In response, officials of the new administration of President Barack Obama have been busy studying the Swedish bank bailout of the 1990s and the Swiss and Dutch health care systems and have been quietly contemplating whether Europe's high fuel taxes and carbon trading system are the right way to limit the burning of fossil fuels that contributes to global warming. In China, where the demise of the American consumer has exposed the perils of excessive savings at home, the government has not only recently proffered a big Keynesian-style stimulus program but has also just announced a three-year plan to provide universal health care. Though modest by comparison, China's health care plan goes in the direction of what has long been considered a fundamental right in Europe.

"When the world's biggest economy and the world's biggest emerging economy look for lessons in the same place at the same time, you know something is up," said Kenneth Rogoff, a professor at Harvard University and former chief economist of the International Monetary Fund, who is one of the 2,500 participants in Davos this year. "We are seeing a paradigm shift towards a more European, a more social state." Such shifts are rare. The Depression of the 1930s eventually ushered in Keynesian demand-side policies and, after a devastating world war, firmly established the need for some sort of welfare state in every major industrial democracy. The oil price shocks of the 1970s and a wave of inflation helped turn the governing approach in the other direction, empowering Ronald Reagan and Margaret Thatcher and other advocates of lower taxes, smaller government and deregulation.

A year ago, at the opening of the 2008 World Economic Forum, a front-page article in the International Herald Tribune suggested that global capitalism was again ripe for such a generational transformation. Amid the worst financial crisis since the Depression, that transformation is now in full swing. With whole swaths of the banking sector being propped up by trillions of dollars in taxpayer funds and hundreds of billions more being dedicated to deficit-financed public spending programs across the world, the most striking feature so far is the comeback of big government. In the world's largest and most emblematic market economy, the surge in the growth of the U.S. government is going to be financed by a huge increase in borrowing, projected to grow from 3 percent of gross domestic product last year to as much as 10 percent this year and into 2010.

"We're moving back towards a mixed economy," said Daniel Yergin, chairman of Cambridge Energy Research Associates in Boston and the author of "Commanding Heights," a history of the last-such paradigm shift, the one toward wider acceptance of the market-driven economy. The new shift is likely to go well beyond expensive short-term fixes. The ferment suggests that ultimately the United States may move closer to Europe, altering the trickle-down economic doctrine of the past three decades and establishing a new social contract aimed at narrowing the gap between the rich and the rest of society, officials and economists say. Obama, who called for a "watchful eye" on the market in his inaugural speech last week, wants to make health insurance available to all Americans. Almost half of the $825 billion pledged to stimulate the economy is earmarked for extending health care and unemployment benefits, and investing in public schools.

Meanwhile, Beijing approved a health reform plan worth 850 billion yuan, or $124 billion, last week that sets out to provide free basic health care to the country's 1.3 billion inhabitants by 2011. Each person covered by the system would receive an annual subsidy of 120 yuan, or $17, starting in 2010. As Pascal Lamy, director general of the World Trade Organization and another Davos regular, put it: "It's a cultural revolution." It is no coincidence that this revolution is unfolding simultaneously in America and China, analysts say. They were opposite poles in the hazardous gentlemen's agreement underpinning global imbalances in recent years - one accumulating ever more debt, the other supplying the world with a glut of savings. But for all their differences, no two countries were more dedicated to the growth-above-all-else capitalist mantra. And no two countries have seen the foundations of their economic models more shaken in recent months.

In the United States, the crisis exposed an unsustainable credit culture and undid a highly sophisticated financial system that accounted for 8 percent of GDP and now needs rebuilding from scratch. In China, where 65 million jobs have been lost in recent years, the export-led model of the past two decades has faltered, in part because America's insatiable demand for Chinese goods has cooled. With Chinese families committed to saving for retirement, health care and education, domestic consumption in China is stuck at 35 percent, half the share in the United States. "The crisis has accelerated things and made domestic demand even more of a priority," said Victor Chu, chairman of First Eastern Investment Group in Hong Kong, the No. 1 direct investment group in China. "Therefore China is strengthening and deepening the social safety net." On paper, the euro zone may look worse than both. Parts of its financial system are reeling, too, and economic growth is expected to fall for much of 2009, while many economists expect the United States to resume growth in the second half of the year. Growth in China is only slowing, not going into reverse.

But unlike the other two, Europe faces less fundamental questioning of its social contract. Higher benefits and broad-based consumption taxes serve as automatic stabilizers of the business cycle, restraining growth in good times but cushioning the downturns. "Europe faces a plain vanilla recession," said Rogoff of Harvard. "It's a deep recession and it's coming with a vengeance. But it's not a paradigm destruction." To be sure, many remain skeptical about Europe's social model and the trade-off between slower economic growth and greater security. Unemployment, which has consistently run higher than in the United States or Japan, is rising again, too. Protests have broken out in several European countries, particularly among the young and immigrants who have not shared in the general prosperity. Its aging population is already pushing up the cost of medical care and retirement security. And whether Europe's model is exportable remains questionable. For the moment, few Americans are prepared to pay for what Europeans take for granted.

Obama's advisers may be looking to Europe for inspiration and many Americans are clamoring for protections against the financial and economic storms, but raising taxes to pay for the bigger government that is on the way is still a political taboo. Taxes in the United States account for about a third of GDP, compared with about 40 percent in France and half in Sweden. Stephen Roach, chairman of Morgan Stanley in Asia, said he did not think that "the American body politic is ready to recognize the trade-off between growth and security." "We want the protection, but we don't want to pay for it," Roach added, noting that European-style consumption taxes or energy taxes were unlikely to proposed in the near future. As a result, many economists see a complex new interplay between markets and the state emerging. "We are going into an era with deeper suspicions of both markets and governments," said Joseph Stiglitz, a Nobel-winning economist who teaches at Columbia University in New York. "There will be more emphasis on the welfare state. But there will also be more emphasis on incentives within the welfare state."

One open question is whether the United States and China can undergo such a fundamental economic shift without heightening the tensions that already exist. It could reinforce American-Chinese strategic relations by highlighting their mutual dependence. But as the economic crisis unfolds it could also lead to protectionist saber rattling. Last week, Timothy Geithner, the new U.S. Treasury secretary, said that Obama thought China was "manipulating" its currency, heralding a harder line toward Beijing. Lamy of the WTO warned that there was already evidence that tariffs and anti-dumping measures were on the rise, though still generally within the limits of trade law. "So far it's nothing dramatic," Lamy said. "But that doesn't mean there isn't the protectionist temptation. There is always a time lag before such measures are put into place."

Betting against the creditworthiness, or continued euro-area membership, of Portugal, Italy, Ireland, Greece and Spain, has become a mainstream activity. Once the province of marginalised euro-sceptics and sensation seeking columns (such as this one), it seems to be attracting more attention, in part because it has been so profitable. For example, back in late June, when we last reviewed this euro spread-widening trade, the extra interest (spread) paid by Italian 10-year bonds over that of German 10-year bonds was about 50 or 60 basis points. Recently, it has been closing on three times that level. However, I am now beginning to think that the forces that created the success of the trade could turn it into a trap.

Betting against a sovereign government, and winning, should make one very nervous. As long as there was no imminent threat of euro-area financial crises, the euro spread-widening trade was an entertaining and profitable game that could be executed with low transaction costs and little execution risk. Before the autumn’s credit crisis the dealers and banks were perfectly happy to pick up a basis point or two selling total return swaps that let speculators go short one euro-country’s issuance, and long another’s. The real problem with selling the risk/reward to one’s partners was that for many months, or even years, shorting the weaker European economies was less than gripping.

Now, unfortunately, it’s interesting, and the risks of executing the strategy will only increase. But just how good a sense of humour do sovereign governments have about traders and the like betting against their character and economic capacity? Not much these days. Those of us with memories that stretch back to the 1970s, or earlier, remember “exchange controls”. The UK controls, for example, were in place from 1939 to 1979. Of course the Maastricht Treaty amendments to European law prohibit member countries from restricting the free movement of capital. There are, however, a few holes in that prohibition. For example, the Maastricht Treaty’s Article 73(d) says the previous provision establishing free capital flows within Europe “shall be without prejudice to the right of Member States ... to take all requisite measures to prevent infringements of national law and regulations, in particular in the field of taxation and the prudential supervision of financial institutions ... or to take measures which are justified on the grounds of public policy or public security”.

That’s an opening the size of the Gotthard Tunnel for any government that decides it doesn’t like a bunch of rootless cosmopolite speculators borrowing its bonds for the purpose of short selling. Say. Oh, and the EU as a whole is subject to exchange controls when Brussels decides they’re a good idea. There’s Article 73(f) (Maastricht numbering). “Where, in exceptional circumstances, movements of capital to or from third countries cause, or threaten to cause, serious difficulties for the operation of economic and monetary union, the Council, acting by a qualified majority, on a proposal from the Commission, and after consulting with the ECB, may take safeguard measures with regard to third countries for a period not exceeding six months ... ” So no exchange controls again; just “safeguard measures”. They aren’t safeguarding you, Mr Macro Manager.

You could argue that you were borrowing Spanish bonds and selling them short because it wasn’t you, but Spain’s lack of competitiveness that was causing those “serious difficulties for the operation of economic and monetary union”. But while I would agree with you, I don’t think those tax and banking inspectors would care much about my opinion, or yours. So your account would remain frozen until all those questions they raise are cleared up. I wondered about my interpretation of European sovereigns’ rights, so I called Cleary Gottlieb, the law firm that advised Argentina on its devaluation-default-de-pegging whatever. They wouldn’t even say for the record whether anyone had asked their opinion. Jonathan Blackman, a partner in the firm’s sovereign practice, offered that: “Countries will individually or collectively do what is necessary to protect themselves from catastrophic events. As (US Supreme Court) Justice (Robert) Jackson said, ‘the Constitution is not a suicide pact’. That is also true of the treaty governing the euro.”

In other words, you can bet against the weaker European governments until it really matters. Then you will probably lose, one way or another, in an unexpected way. One monetary economist notes: “A few weeks ago, everyone in the market was pro euro. Now it’s apparent that the euro is making things worse.” For the targeted countries, the only way out of their lack of competitiveness would be either drastic wage deflation, which would lead to a myriad of defaults, or a supernatural increase in productivity. The numbers, though, are daunting. Spain would have to make up for a 17 per cent rise in unit labour costs, compared with the rest of the industrial world, since 1999. In these circumstances, successful speculators can count on being targeted for revenge.

Global pension fund assets in the 11 major pension markets fell by $5 trillion (3.6 trillion pounds) in 2008 hit by volatile markets, a Watson Wyatt report said on Monday. The study said that over 2008, global pension assets fell to $20 trillion from $25 trillion, a fall of 19 percent which took assets below 2005 levels. Another reason for the decrease was lower government bond yields, which pushed pension liabilities further up. Pension schemes calculate their liabilities against AA-rated corporate bond yields --if yields fall, liabilities rise and vice versa. Watson Wyatt said it had selected government bond yields to facilitate liability comparisons across the 11 countries. All countries in 2008 saw significant negative growth in pension assets, the study noted, except for Germany, which was protected by its high allocation to bonds.

Despite losing market share in the past 10 years the United States, Japan and the United Kingdom remained the largest pension markets in the world, accounting for 61 percent, 13 percent and 9 percent respectively of total pension global fund assets. Australia emerged as the fastest-growing market and the country with the highest proportion of defined-contribution pension vehicles. Assets invested in defined-contribution pension schemes, account for 45 percent of global pension assets, up from 30 percent in 1998. Pension schemes also changed the way they invest their funds in the five years to 2008. In the seven most-developed pension markets, which include the United Kingdom, the Netherlands and the United States, equity allocations fell to 42 percent from 51 percent in the five years to 2008, having reached a high of 60 percent in 1998.

During the same period bond allocations increased to 40 percent from 36 percent. Alternative investments allocations like real estate, extent hedge funds, private equity and commodities, grew to 17 percent from 12 percent. "The pensions system is being tested on every level," said Roger Urwin, global head of investment content at Watson Wyatt. "Most notable in 2008 were the impacts on it of credit and collateral risk as well as greater issues around liquidity and volatility. These have been exacerbated by the underperformance of many investment managers relative to their benchmarks," he also said. "We have seen some successes from diversification and hedging strategies. But overall we see an industry facing a mountainous challenge," he added.

Who needs the US government to create a new "bad bank" when it’s got Bank of America? Incessant deal-making by the Charlotte bank’s boss Ken Lewis during the financial crisis has made the institution a de facto repository for all manner of toxic assets. For this and his lack of candour over the Merrill Lynch mess, Bank of America’s board of directors must show Lewis the door. Sure, the government may have egged Lewis on to close his acquisition of Merrill, and even winked at his takeover of troubled mortgage lender Countrywide Financial. But as details emerge about his oversight of BofA’s recent purchase of the largest US stockbroker, it has become clear that Lewis failed to properly protect the interests of his shareholders from any such external pressures. As a result, the bank has not just had to ask for a second, dilutive helping of the Treasury’s Troubled Asset Relief Programme and suspend its dividend. It has led to one of the greatest destructions of shareholder value in the history of finance. Over the past year, the 84pc decline in BofA’s share price has cost shareholders some $250bn.

True, other banks, like Citigroup, have seen analogous value wipe-outs. But most of the problems at Citi occurred under previous management. It’s also safe to say that its current chief executive, Vikram Pandit, is no poster child for job security. By contrast, BofA’s current problems happened under Lewis’s gaze, which the Merrill fiasco suggests was far from steely. Within weeks of closing, BofA revealed a $15.3bn loss from write-downs on Merrill’s books and said Merrill paid out compensation and benefits that totalled only 6pc less than it distributed in 2007, and did so a month earlier than usual. The bank says it had no legal right to challenge the payouts. But Lewis should have thought of that when he cut the deal.

That he didn’t exhibits how little flair he has for the sort of due diligence required of a serial dealmaker. Then there’s the matter of his handling of the news. In the ensuing public ruckus, BofA did little to disabuse investors of their assumption that the losses occurred as a result of new positions, or that Merrill had pulled one over on its new owner regarding bonuses. Only after Lewis dismissed John Thain did the former Merrill chief publicly state that the losses "were incurred almost entirely on legacy positions" and the bonuses "were all determined together with" BofA. Corporate executives must accept responsibility for failures if they’re to keep their shareholders’ trust. When they don’t, it is up to the board to make sure blame is apportioned appropriately. Lewis hasn’t come clean. BofA’s board must.

How many banks will fail this year? No one knows of course, but the answer is many. So far in 2009, we've already had three, putting us on a one-per-week pace. That could mean a doubling of last year's tally of 25, and only slightly less than the total number of failures heretofore over the entire decade (57). On Friday, regulators shut down First Centennial Bank in California of Redlands. (Redlands, the "Jewel of the Inland Empire" is located in San Bernardino County off I-10 on the way to Joshua Tree and Palm Springs.) On January 16, Bank of Clark County, Vancouver, Washington (love the Vancouver Sausage Fest each September) and National Bank of Commerce, Berkeley, Illinois (home to World Dryer Corp) both went splat.

It's dire and scary stuff, but sadly we have seen much worse in this country and you don't have to go back to the 1930s to find it. True, the 1930s were a disaster for banks. In the panic of 1933, more than 4,000 failed which led to the creation of the Federal Deposit Insurance Corporation. But the FDIC hardly made bank failures obsolete. Since 1934 some 3,565 banks have flamed out in this country. A great majority of them hit the wall in the 15-year period between 1979 and 1994. The peak year was 1989, when 534 banks either failed or required "assistance transactions" from the FDIC. This massive failing was of course brought on by the savings and loan crisis that devastated thousands of banks. (To be clear not all these banks technically failed. The FDIC website indicates there are nine possible interventions, including some where the institution's charter survives, such as "reprivatizations," and others where the charter is terminated, such as a purchase and assumption where the institution is sold. No question though that every bank on this list at the FDIC website had basically failed.)

So 25 or 50 bank failures, or even a few dozen more, pales in comparison to the number of failures 20 years ago. But that's cold comfort for a number of reasons. First, remember that big banks were in lousy shape back then too. In May 1984, Continental Illinois, the nation's seventh-largest bank became insolvent. Interestingly the bank, which became 80% owned by the U.S. government, was bought by Bank of America in 1994, which of course has its own problems right now. Other big bank failures back then include First Republic of Dallas (1988) and Bank of New England (1991). You may also remember that in 1990, Saudi investor Prince Alwaleed pumped hundreds of millions of dollars into Citibank, (as he did again recently), to shore up that battered bank's balance sheets. Alwaleed's Wiki page notes, "his investments in Citibank earned him the title of "Saudi Warren Buffett," though the past tense here seems most appropriate.

Even with all that historical pain. though, I would argue the situation is worse today. True we don't have the plethora of failures as we did back in the day--though we still might. But last year's Washington Mutual's failure far and away topped Continental Illinois's demise as the biggest in U.S. history and IndyMac now checks in as #3. And, of course, I think it is unassailable that Citi is in worse shape today with tens of billions of dollars of losses and tens of billions of dollars of government guarantees. Bank of America is in the deep soup too. Not a surprise then that the Keefe Bruyette Woods Bank Index (which has 24 bank stocks) has fallen some 80% from its peak in February 2007. That's huge! But it is also almost exactly the same decline financial stocks experienced in 1929 to 1933. Bottom line is this: When the only benchmarks we have to compare the current situation with the banks are the 1930s and the savings and loan crisis, you know you are a really bad place.

Hold onto your wallets. The bankers are coming bank for more money. They burned through the $350 billion that we gave them in the first round of the Troubled Asset Relief Program (TARP) and they are worried that even the second $350 billion will not be enough money to keep them solvent. The selective leaks from Treasury tell us that the banks will need far more money to cover their bad debts. The latest story is that the banks want to sell us their bad assets at above market prices, which was the original plan that Treasury Secretary Paulson proposed, except the banks want to push off their junk on an even bigger scale. In one version, the government would set up a Resolution Trust-type corporation (RTC), like we did with the bankrupt Savings and Loans in the 80s, which would hold all the garbage and then gradually resell it to the private sector to recover a portion of what the government paid.

This is a reasonable course, except there is one big difference between what we did with the S&Ls in the 80s and the leaked plan being floated. The S&Ls were taken over by the government and then resold to the private sector. These were bankrupt institutions that were put out of business. The stockholders were wiped out, which is what is supposed to happen to stock holders when their company goes bankrupt. But this is not what happens in the plan being discusses. In this plan, the taxpayers just do the banks the great favor of paying above market prices for their junk so that we can relieve them of the burden of their past mistakes. The taxpayers get to eat the losses and the bank executives and their shareholders go on their merry way.

These folks are not market fundamentalist types. The Wall Street view of the world, and apparently the view of at least some people in the Obama administration, is that the government always is there to help a bank or banker in need. The idea that we would give one more penny to this crew that has wrecked the economy should make taxpayers furious. There is a legitimate public interest in keeping the banks operating; a modern economy needs a well-operating financial system. But, there is zero public interest in rewarding shareholders and overpaid banks executives. These executives bankrupted their banks and brought the economy down with them. They belong in an unemployment line not collecting multi-million dollar paychecks in their designer office suites.

The obvious answer is to take over the insolvent banks, just as we did with the insolvent S&Ls. The government should form an RTC as we did in the 80s, which would dispose of the assets over time, collecting as much money as possible for the government. The bankrupt banks would be restructured and sold back to the private sector as soon as their books were straightened out. The point of the exercise is not have the government run the banks, the point is to keep the financial system running without giving even more money to the richest people in the country.

This is the only reasonable solution to the mess that the bankers have created. The other solutions are simply efforts to transfer dollars from hardworking taxpayers to overpaid and incompetent bank executives. It is hard to believe that anyone would take it seriously, if not for the enormous political power of the Wall Street gang. It's too bad that the Republicans' anger over giving tax breaks to workers who did not pay income taxes does not extend to giving tax dollars to Wall Street banks who have wrecked our economy. Where are the anti-government conservatives when we need them?

Caterpillar Inc., Sprint Nextel Corp. and Home Depot Inc. led companies today announcing at least 72,500 job cuts as sales withered and construction slowed amid a global economic recession that may persist through 2009. The biggest layoffs were at Peoria, Illinois-based Caterpillar. The world's largest maker of construction equipment said it's cutting 20,000 jobs after fourth-quarter profit fell by almost a third. Pfizer Inc., the New York-based drugmaker that's acquiring competitor Wyeth for $US68 billion ($104 billion), said it will close five factories and eliminate 19,000 jobs, or 15%, of the combined company's workforce. The firings came as American jobless claims hit a 26-year high, reaching 589,000 in the week ended Jan. 17, as shrinking demand for products and services forced companies to lower costs.

Employers "are each cutting thousands of jobs. These are not just numbers on a page,'' US President Barack Obama said today at the White House. "We cannot afford delays'' in passing the economic stimulus program now before Congress. Sprint Nextel Corp., the US wireless carrier, will eliminate 8,000 jobs, or 14% of its workforce, in order to reduce expenses by $US1.2 billion a year. Home Depot Inc., the world's largest home-improvement retailer, said it will cut 7,000 jobs, or 2% of its workforce, and exit its Expo home-décor business. "Certainly since 2001, with the dot-com collapse, we haven't seen these kinds of large cuts,'' James Pedderson, a spokesman for Challenger Gray & Christmas Inc., a Chicago-based provider of executive-outplacement services, said in an interview. "In terms of the number of companies and the number of cuts, this morning is certainly unusual.''

General Motors Corp., the largest US automaker, said it will eliminate shifts at Michigan and Ohio plants, shedding 2,000 jobs as sales drop. In Europe, ING Groep NV, the biggest Dutch financial- services company, said it will reduce its workforce by 5.4%, eliminating 7,000 jobs, after its second consecutive quarterly loss. Royal Philips Electronics NV, Europe's largest maker of consumer electronics, said it will cut 6,000 positions after its first quarterly loss in almost six years. Corus, the unit of India's Tata Steel Ltd. that's Europe's second-biggest steelmaker, said it will reduce its workforce by 8%, or 3,500 jobs, as demand from builders and automakers declines.

Economists say steep job cuts at Caterpillar, Sprint, and Pfizer may only signal the halfway point. In a single day, on Jan. 26, at least 50,000 new layoffs were announced at companies as varied as telecom giant Sprint Nextel (S), construction equipment maker Caterpillar (CAT), semiconductor manufacturer Texas Instruments (TXN), and pharmaceutical house Pfizer (PFE). It was a stark reminder of how rapidly the recession is claiming jobs. Already 170,000 jobs have been lost in January. The U.S. economy lost 2.6 million jobs in 2008. The worst news, though, may be that some economists say in their most optimistic view the U.S. has only reached the halfway mark in terms of the layoffs expected for this recession. A growing number of economists also say that the U.S. economy is not just shedding jobs temporarily, but may be undergoing a painful restructuring process that will eliminate some types of jobs for good. "We are seeing very large layoffs—the kind you get when companies don't expect to be re-employing any time soon," says Peter Morici, a professor at the Robert H. Smith School of Business at the University of Maryland. "They [represent] structural, not cyclical, changes to the economy. We're looking at a permanently smaller economy with prolonged unemployment at an unacceptable level."

Morici says that housing, real estate, automobiles, finance, and retail sectors are resetting to "permanent lower levels" of employment. Mike Montgomery, an economist with IHS Global Insight, asserts that many jobs in autos, manufacturing, apparel, and textiles aren't coming back. Those industries "have been in a long-term decline, and the recession is knocking them out." "We are very early in the cycle," says Morici. "We are going to see the fury of the Old Testament for what we have done to the economy." Many economists see nationwide unemployment rising to at least 9% this year, possibly reaching double digits in 2010. Thirteen states are already above the national average of 7.2%, with Michigan (9.6%), Rhode Island (9.3%), California (8.4%), and South Carolina (8.4%) topping the list. On Jan. 26, a National Association for Business Economics (NABE) survey depicted the worst business conditions in the U.S. since the report's inception in 1982. Among the cuts announced on Jan. 26:

• Caterpillar, the world's largest maker of mining and construction equipment, announced 5,000 new layoffs on top of several earlier actions. The latest cuts of support and management employees will be made globally by the end of March. The company says it is in the process of shedding about 20,000 jobs. The company employs 112,000 worldwide.• Wireless phone carrier Sprint said it is eliminating about 8,000 positions in the first quarter as it seeks to cut annual costs by $1.2 billion. The layoffs will trim about 14% of Sprint Nextel's 56,000 employees. The company said it is also suspending its 401(k) match for the year, extending a freeze on salary increases, and suspending a tuition reimbursement program.• Pharmaceutical company Pfizer, which announced a deal to buy rival drugmaker Wyeth (WYE) for $68 billion, said it would cut 8,000 jobs. The cuts will begin in the first quarter and are to be complete by 2011, according to company spokesman Ray Kerins. Cuts will include most departments, from administration and sales to manufacturing and research.• Home-improvement retailer Home Depot (HD) said it was closing four small units—Expo Design Centers, YardBIRDS, Design Centers, and HD Bath, a bath remodeling business—trimming about 7,000 jobs in the process. The cuts represent about 2% of Home Depot's total workforce.• General Motors (GM) said it will cut 2,000 jobs at plants in Michigan and Ohio and will halt production for several weeks at nine plants over the next six months because of slow sales. The company said the layoffs are part of its efforts to "align production with market demand."• Texas Instruments, which makes chips for cell phones and other gadgets, said it will cut 3,400 jobs because demand has slackened amid a slowing economy. It will cut 12% of its workforce—1,800 jobs through layoffs and another 1,600 through voluntary retirements and departures.

To try to stem the layoffs and reclaim some of those lost jobs, President Barack Obama has proposed an $825 billion economic stimulus package that is making its way through Congress. The plan would pump money into the economy —by way of spending on roads, mass transit, technology, and energy projects, and through tax cuts—in the hope of jump-starting job growth. The goal is to create 3 million to 4 million jobs. Economists who favor such heavy government spending say the package would prevent a 0.75% to 1.5% rise in the unemployment rate by the start of 2010. "The [stimulus] plan will make a measurable difference in the job market," says Mark Zandi, chief economist at Moodys.com (MCO). "The downside risk comes if it doesn't pass." In the NABE survey, 52% of economic forecasters said they expected gross domestic product to fall by more than 1% this year. Many analysts predict the economy will have contracted at an annual pace of 5.4% in the fourth quarter of 2008 when the government releases that report on Friday. If they are correct, that would mark the worst performance since a 6.4% drop in the first quarter of 1982.

One reason for the shrinkage is that the era of debt-based consumption is giving way to one in which consumer spending slows as incomes fall. "The U.S. consumer is going from powering the global economy to following along [global economic trends]," says Zandi. "Spending at best will match their incomes and will likely fall short of it." As layoff announcements mount, more CEOs suggest their companies are undergoing fundamental changes. "We're certainly in the midst of a once-in-a-lifetime set of economic conditions," said Microsoft (MSFT) Chief Executive Steve Ballmer during a conference call on Jan. 22, after the company announced weaker-than-expected quarterly earnings. "The economy is resetting to a lower level of business and consumer spending." That day, Microsoft announced 5,000 layoffs, or 5.5% of its workforce, as well as reductions in thousands of contract jobs. But because many businesses were already operating with a lean workforce when the recession began, there is some hope they will fill vacated positions when the economy improves. "The vast majority of the job loss is strictly short-term," says Montgomery at IHS Global Insight. "When consumer demand and sales come back, the jobs will come back."

Furloughs, wage reductions, hiring freezes and shorter hours simply did not do enough. A year into this recession, companies across the board are resorting to mass job cuts. Home Depot, Caterpillar, Sprint Nextel and at least eight other companies announced on Monday they would cut more than 75,000 jobs in the United States and around the world — a gloomy start to the workweek for employees anxious about holding their own as the economy sinks. Caterpillar, the maker of heavy equipment, is slashing its payrolls by 16 percent. Texas Instruments said late in the day that it would eliminate 3,400 jobs, or 12 percent of its work force.

Jobs began disappearing in home building and mortgage operations early in the recession, then across finance and banking more generally. Now the ax is falling across large swaths of manufacturing, retailing and information technology, taking out workers from New York to Seattle. Just last week, Microsoft announced its first significant job cuts ever. Because companies like Microsoft have invested in their workers’ skills and knowledge, they usually delay major work force reductions as long as they can. But with orders for new products and services drying up and financing tight, employers are looking to shrink their costs drastically and are slashing their payrolls, anticipating a protracted decline for business in 2009.

Monday’s parade of negative news comes after months of announcements from other prominent companies like Citigroup, General Electric, Nokia and Harley-Davidson. As part of its acquisition of Wyeth, Pfizer said it would cut the combined workforce by 19,500 employees. On Wednesday, the tally of mass layoffs for December will be released by the Bureau of Labor Statistics. Already, the bureau says the United States economy has shed 2.55 million jobs since the recession began, pushing the unemployment rate up to 7.2 percent last month. The latest round of job cuts — and the additional rounds likely to come as these move through the economy — mean more pain ahead for states as unemployment insurance claims rise and deplete state budgets.

Congress has proposed setting aside $43 billion to assist the states and to provide for new and current recipients of unemployment checks. That money is intended to increase the weekly benefit amounts; to extend how long people can collect payments; to cover more types of workers, like part-timers; and to help states distribute benefits more quickly. It is based largely on an estimate that the unemployment rate will rise to 8 to 9 percent this year even with a stimulus package, according to the proposal summary from the House Appropriations Committee. But if unemployment soars into double digits, as some economists expect, the financing may not be enough.

"The economy is deteriorating at a faster clip than even the most dreary forecasts had expected," said Joseph Brusuelas, an economist who, bucking the current job market trend, will soon start a new job at Moody’s Economy.com. "At the current trend, $43 billion will not be sufficient should we breach 9 percent unemployment and maybe reach into the double digits." President Obama cited the layoff announcements in remarks Monday urging Congress to approve an $825 billion economic stimulus package of tax cuts, emergency benefits and public spending projects. "These are not just numbers on a page," he said. "As with the millions of jobs lost in 2008, these are working men and women whose families have been disrupted and whose dreams have been put on hold."

Charles DiGisco, of Randolph, N.J., is one casualty of the downturn. He said he had been looking for work since Sept. 18, when he lost his job as a vice president for sales and marketing at Master Cutlery, a knife maker. He frequently hears a familiar refrain from would-be employers: "We would hire you, but we’re not hiring anybody." His family’s monthly expenses are four times what Mr. DiGisco collects from unemployment, and he said his family was selling two of its three cars and might dispose of some stocks or dip into retirement funds to keep paying the mortgage. "It takes me 20 years to save it, and it takes me five months to go through it," Mr. DiGisco said. While stimulus spending on public works may take some time to get going, some companies could bring back displaced workers quickly if the government initiative generated new orders.

Caterpillar, for example, had announced buyouts, wage freezes and work stoppages around the holidays because of "a dramatic decline in orders," said Jim Dugan, a spokesman for the company, based in Peoria, Ill.On Monday, the company said that a total of 15,000 permanent and temporary jobs, out of about 125,000, would have been eliminated by the end of this week, and that it would trim 5,000 more by the end of the first quarter. Should orders for earthmovers and other heavy equipment improve, which some expect as countries around the world start building bridges, highways and other public works to help create jobs, Caterpillar can recall some workers quickly.

Many companies, though, may not rush to increase staffs even if business begins to pick up. Andrew Stettner, deputy director of the National Employment Law Project, said downturns often motivate companies to restructure business models permanently, meaning jobs they cut now are unlikely to be replaced. "Structural change is put into overdrive because of the recession," he said, "so who knows for sure how a company like Microsoft will fare?" Sprint Nextel, which announced Monday that it was eliminating 8,000 jobs, or roughly 14 percent of its work force, is similarly facing some tough restructuring decisions as it continues to hemorrhage subscribers. After a dismal holiday shopping season, retailers are letting employees go in droves. More than 66,600 retailing jobs were lost in December, the worst period since the late 1930s.

Home Depot, the home improvement retailer, said Monday it would cut 7,000 jobs, or 2 percent of its workers. Some 5,000 cuts will come through store closings, largely of its upscale Expo chain; the rest will come from corporate support, many at its Atlanta headquarters. Carol B. Tomé, Home Depot’s chief financial officer, said the company had explored ways to save Expo, but "as we kept looking at alternatives, the business kept getting softer and softer." For most of last year, relatively healthy demand for exports gave global companies like Caterpillar a cushion. But with downturns deepening across Europe and Asia, and the dollar strengthening, global demand for costlier American goods has faltered. "There really isn’t any hiding place for companies anymore," said Nigel Gault, chief United States economist at IHS Global Insight. "The recent numbers coming in from the rest of the world are disastrous."

The nation's retailers had a rough 2008, but this year will likely be even scarier, according to a sales forecast released Tuesday from the world's largest retail trade organization. Retailers are expected to record a 0.5 percent drop in revenue in 2009, the first annual decline in three decades and perhaps much longer, according to a National Retail Federation forecast released Tuesday. That's well below the modest 1.4 percent gain they recorded for 2008. Massive layoffs, slumping home prices and tight credit are keeping shoppers tightfisted. The NRF estimated that retail sales for the first half of 2009 will fall 2.5 percent. Then, they'll show a 1.1 percent decline in the third quarter and rebound to a 3.6 percent increase in the fourth quarter, aided by an anticipated government economic stimulus. Another factor that should help sales figures for late 2009 is that sales were so dismal in the fourth quarter of 2008 -- declining 1.7 percent, according to Rosalind Wells, NRF's chief economist.

For November and December combined, sales fell 2.8 percent, well below the association's forecast of a 2.2 percent gain. "Most of the consumer behavior we saw in 2008 will continue well into this year," said Wells. She said she's never seen an annual decline in the 30-plus years she has tracked retail sales. She started with NRF in 1995 but had previously worked as J.C. Penney's chief economist from 1978 to 1988. NRF's retail sales figures exclude business from automobile sales, gas stations and restaurants. One of the key challenges for the retail industry is the massive layoffs across all sectors that appear to be accelerating, Wells said. "Employment is one of the foremost criteria we look for, which in turns means income," Wells said. "Without a good employment trend, it is very hard to have confident shoppers to go out and spend. Right now, employment numbers have been terrible, and more layoffs are to come."

Several big names in corporate America announced layoffs Monday. Pharmaceutical giant Pfizer Inc., which is buying rival drug maker Wyeth in a $68 billion deal, and Sprint Nextel Corp., the country's third-largest wireless provider, each plan to slash 8,000 jobs. Home Depot Inc., the biggest home improvement retailer in the U.S., is shedding 7,000 jobs, and General Motors Corp. said it will cut 2,000 jobs at plants in Michigan and Ohio due to weak sales. Caterpillar Inc., the world's largest maker of mining and construction equipment, announced 5,000 new layoffs on top of several earlier actions. Wells said she felt somewhat encouraged by data released Monday by the National Association of Realtors showing an unexpected increase in sales of existing homes helped by booming sales of bargain-basement foreclosures in California and Florida. But she said housing must improve substantially before the economy can start to pick up. The NRF predictions are being released on the same day the New York-based private research group The Conference Board is slated to announce its January index on consumer sentiment, which economists expect will remain near all-time lows. The reading is expected to be up slightly, at 39, from 38 in December, which marked the lowest point since at least 1967, when the index began. In January a year ago, consumer confidence was at 87.3. The index is compiled from a survey of 5,000 U.S. households and will be released at 10 a.m. EST.

U.S. Treasury Secretary Timothy Geithner announced new rules on Tuesday to limit lobbying by companies that receive government financial assistance in one of his first moves after being sworn into office. The rules restrict lobbyist contacts in connection with applications for or disbursement of the Treasury's $700 billion bailout program, the Treasury said in a statement. "These new rules go beyond the approach taken under the Emergency Economic Stabilization Act to date and will help ensure a new level of openness and accountability going forward," the Treasury said.

The rules will use as a model the protections that limit political influence on tax matters, and require the Treasury to certify each investment decision is based only on investment criteria and facts of the case. The rules are being unveiled as Congress prepares to release the second $350 billion of the Troubled Asset Relief Program after widespread disappointment with the handling of the first half by former Treasury Secretary Henry Paulson. Obama administration officials also have signaled that they may seek additional funds to shore up the financial system as they prepare a comprehensive stabilization plan due by the end of next week.

Many lawmakers feel that there were too few controls on companies receiving the first half of the TARP money, no clear way to track whether banks used the funds to boost lending and too little oversight for the program. The new rules also aim for transparency by using objective criteria, including providing capital investments only to those banks recommended by their primary regulator. The Treasury said it will publish a detailed description of the investment review process and ensure adequate resources are available to handle applications as quickly as possible.

The pound rose against the dollar when trading began in London on Tuesday, rising back above the $1.40 mark after hitting a 23-year low last week. Sterling opened up more than two cents at $1.4172 after closing up almost three cents yesterday. The fall was attributed by currency experts to a weaker dollar because of uncertainty in the US over possible quantitative easing by the Federal Reserve. Gloomy economic data are also expected this week, culminating with fourth quarter gross domestic product figures on Friday. A 5.4pc fall is expected, but some economists are expecting a bigger fall, including those at the Royal Bank of Canada who predict a 6.1pc contraction. The dollar may also have been hit by concerns over China's relationship with the US, after Barack Obama's administration accused the country of manipulating the yuan for competitive purposes. The pound has been boosted by the declaration from Barclays yesterday that it will not have to raise fresh capital, alleviating some of the fears over the prospects for the UK banking sector. Sterling also rose against the euro this morning, up less than a cent at €1.0684, and was up against a basket of major currencies.

If you believe our leaders, we can't find anyone to reform the financial system other than tax evaders and undistinguished and overpaid career regulators. When Robert Rubin explains away the financial crisis by saying "nobody was prepared for this" we have to just shrug and accept it. How else could we end up getting such yawn-inducing candidates as Tim Geithner for Treasury, Mary Schapiro for the Securities and Exchange Commission, Dick Parsons as chairman of Citigroup Inc. and Neel Kashkari holding the keys to the bailout vault? Neither the old or new administration has inspired much confidence with its picks for top jobs. They are flawed candidates, each with a history that requires the public to grit its teeth, hold its nose and hope for the best.

Maybe in four years we'll be tipping our hats, wondering why we didn't buy brokerage ETFs, but until then we are left to wonder why President Obama has overlooked bankers with far better pedigrees for top jobs. No, we're not just talking pie-in-the-sky candidates such as Jamie Dimon at J.P. Morgan Chase & Co., but real candidates who would be willing to take reform roles.What follows is an admittedly incomplete list. No massive search was done to come up with these three names. But if I can come up with these people off the top of my head, why can't anyone in Washington find these guys?

John AllisonThe chairman of BB&T Corp. not only led his bank through the dicey mortgage waters, but has been drafted as a populist hero for his stand against the government's banking bailout. It was Allison who wrote a stinging letter to Congress on Sept. 23, arguing that the contemplated bailout would reward poorly managed banks at the expense of properly managed banks like Winston-Salem, N.C.-based BB&T. Allison, 58, urged some controversial reforms like the elimination of "fair value" accounting, but as someone who built BB&T into one of the top 15-biggest banks by assets in the U.S. market during the last 30 years, and largely avoided the toxic mortgage mess, his record is hard to debate. Plus, he doesn't mince words.

"The primary beneficiaries of the proposed rescue are Goldman Sachs and Morgan Stanley," Allison wrote. "The Treasury has a number of smart individuals, including Hank Paulson. However, Treasury is totally dominated by investment bankers. They do not have knowledge of the commercial banking industry." Allison retired as chief executive at yearend. The bank is in the capable hands of Kelly King, whom Allison groomed for years as his successor. The only question I'd have for Allison is if he wanted to run the Treasury or the Fed.

Dick KovacevichOnce Allison has picked his job, the smart thing to do would be to bring in Kovacevich, who like Allison has relinquished day-to-day control at Wells Fargo Corp., in San Francisco, and has settled into a role as chairman. Wells made its big splash by agreeing to acquire a near-failed Wachovia Corp. last year. A lot of people made much of the fact Wells Fargo avoided the need of government backing and was willing to pay a decent premium, $15.1 billion when announced in October. I like Wells and Kovacevich, 65, for other reasons. For one, Wells has reported a $6.7 billion profit during the last four quarters ending Sept. 30. Wells has improved its Tier 1 Capital levels. It's avoided toxic paper. It's getting its message across: customers who have fled troubled competitors are putting their cash with Wells. This success is largely due to Kovacevich who served as CEO from 1998 to 2007, and didn't bow to pressure even though rivals such as Countrywide and Washington Mutual were growing their mortgage operations faster than Wells Fargo earlier in the decade.

Ralph BabbFinally, a nod to Ralph Babb, the 60-year-old chairman and chief executive of Dallas-based Comerica Inc.. Babb isn't even as well known as the other banking executives, and to be honest, he's a mystery to us who follow Wall Street in the Northeast. But if there's anything that recommends him, it is this: Comerica is the biggest bank in Michigan. Knowing what's happening to the auto industry, how it lost tens of thousands of jobs, is there anyone who isn't impressed that Comerica made nearly $200 million during the last 12 months? Here's another reason to bring him to Washington: the bank only had $133 million in charge offs in the fourth quarter on a balance sheet of more than $65 billion, and that was double the rate of a year ago.

Analysts, such as Peter Winter at Bank of Montreal, note with a hint of astonishment that credit has held better at Comerica than many of its competitors. Consider that unemployment in Michigan is now about 10% and the state lost 30,000 jobs in October and November alone, according to the Bureau of Labor Statistics. Sure, Comerica has had trouble. Babb had to cut jobs. Profits fell to just $3 million in the fourth quarter. He's been criticized for abandoning Detroit, where the bank had been based for more than 150 years. And given economic conditions, Babb and Comerica are definitely going to have a tough 2009.Popular or not, Babb has done enough that he would merit an interview in my book.

Though they didn't have the senior positions our three top candidates had, there are some other people out there who saw this financial crisis coming and ought to be rewarded by getting a chance to lead us out of the woods. It's a group that includes people like Christopher Wood, a chief strategist a Credit Lyonaisse's Asia brokerage who told investors to get out of the U.S. mortgage securities market in 2005 and to sell U.S. and European banks in 2007. It includes Peter Schiff, a regular on business TV shows, who warned against a real estate collapse. Alone, that prediction was hardly unique, but what set Schiff apart was what he forecast as the fallout: deep recession, credit crunch and bank failures. Yes, that sounds familiar.

Charles Schwab hasn't done too badly either. His firm has prospered even though it didn't build and package mortgage, asset or commercial mortgage-backed securities. Charles Schwab Co. simply is a retail brokerage. Imagine that. And how about Paris Welch? She was the mortgage lender who wrote U.S. regulators in 2006 warning them about lax lending standards. "Expect fallout, expect foreclosures, expect horror stories." There is one knock on all of these candidates: none has any significant government experience. Of course, judging by the government's performance, you already knew that.

America's recession is moving into its second year, with the situation only worsening. The hope that President Obama will be able to get us out of the mess is tempered by the reality that throwing hundreds of billions of dollars at the banks has failed to restore them to health, or even to resuscitate the flow of lending. Every day brings further evidence that the losses are greater than had been expected and more and more money will be required. The question is at last being raised: Perhaps the entire strategy is flawed? Perhaps what is needed is a fundamental rethinking. The Paulson-Bernanke-Geithner strategy was based on the realization that maintaining the flow of credit was essential for the economy. But it was also based on a failure to grasp some of the fundamental changes in our financial sector since the Great Depression, and even in the last two decades.

For a while, there was hope that simply lowering interest rates enough, flooding the economy with money, would suffice; but three quarters of a century ago, Keynes explained why, in a downturn such as this, monetary policy is likely to be ineffective. It is like pushing on a string. Then there was the hope that if the government stood ready to help the banks with enough money -- and enough was a lot -- confidence would be restored, and with the restoration of confidence, asset prices would increase and lending would be restored. Remarkably, Bush administration Treasury Secretary Henry Paulson and company simply didn't understand that the banks had made bad loans and engaged in reckless gambling. There had been a bubble, and the bubble had broken. No amount of talking would change these realities.

It soon became clear that just saying that we were ready to spend the money would not suffice. We actually had to get it into the banks. The question was how. At first, the architects of the bailout argued (with complete and utter confidence) that the best way to do this was buying the toxic assets (those in the financial market didn't like the pejorative term, so they used the term "troubled assets") -- the assets that no one in the private sector would touch with a 10-foot pole. It should have been obvious that this could not be done in a quick way; it took a few weeks for this crushing reality to dawn on them. Besides, there was a fundamental problem: how to value the assets. And if we valued them correctly, it was clear that there would still be a big hole in banks' balance sheets, impeding their ability to lend. Then came the idea of equity injection, without strings, so that as we poured money into the banks, they poured out money, to their executives in the form of bonuses, to their shareholders in the form of dividends.

Some of what they had left over they used to buy other banks -- to pursue strategic goals for which they could not have found private finance. The last thing in their mind was to restart lending. The underlying problem is simple: Even in the heyday of finance, there was a huge gap between private rewards and social returns. The bank managers have taken home huge paychecks, even though, over the past five years, the net profits of many of the banks have (in total) been negative. And the social returns have even been less -- the financial sector is supposed to allocate capital and manage risk, and it did neither well. Our economy is paying the price for these failures -- to the tune of hundreds of billions of dollars. But this ever-present problem has now grown worse. In effect, the American taxpayers are the major provider of finance to the banks. In some cases, the value of our equity injection, guarantees, and other forms of assistance dwarf the value of the "private" sector's equity contribution; yet we have no voice in how the banks are run.

This helps us understand the reason why banks have not started to lend again. Put yourself in the position of a bank manager, trying to get through this mess. At this juncture, in spite of the massive government cash injections, he sees his equity dwindling. The banks -- who prided themselves on being risk managers -- finally, and a little too late -- seem to have recognized the risk that they have taken on in the past five years. Leverage, or borrowing, gives big returns when things are going well, but when things turn sour, it is a recipe for disaster. It was not unusual for investment banks to "leverage" themselves by borrowing amounts equal to 25 or 30 times their equity. At "just" 25 to 1 leverage, a 4 percent fall in the price of assets wipes out a bank's net worth -- and we have seen far more precipitous falls in asset prices. Putting another $20 billion in a bank with $2 trillion of assets will be wiped out with just a 1 percent fall in asset prices. What's the point?

It seems that some of our government officials have finally gotten around to doing some of this elementary arithmetic. So they have come up with another strategy: We'll "insure" the banks, i.e., take the downside risk off of them. The problem is similar to that confronting the original "cash for trash" initiative: How do we determine the right price for the insurance? And almost surely, if we charge the right price, these institutions are bankrupt. They will need massive equity injections and insurance. There is a slight variant version of this, much like the original Paulson proposal: Buy the bad assets, but this time, not on a one by one basis, but in large bundles. Again, the problem is -- how do we value the bundles of toxic waste we take off the banks? The suspicion is that the banks have a simple answer: Don't worry about the details. Just give us a big wad of cash.

This variant adds another twist of the kind of financial alchemy that got the country into the mess. Somehow, there is a notion that by moving the assets around, putting the bad assets in an aggregator bank run by the government, things will get better. Is the rationale that the government is better at disposing of garbage, while the private sector is better at making loans? The record of our financial system in assessing credit worthiness -- evidenced not just by this bailout, but by the repeated bailouts over the past 25 years -- provides little convincing evidence. But even were we to do all this -- with uncertain risks to our future national debt -- there is still no assurance of a resumption of lending. For the reality is we are in a recession, and risks are high in a recession. Having been burned once, many bankers are staying away from the fire. Besides, many of the problems that afflict the financial sector are more pervasive. General Motors and GE both got into the finance business, and both showed that banks had no monopoly on bad risk management.

Many a bank may decide that the better strategy is a conservative one: Hoard one's cash, wait until things settle down, hope that you are among the few surviving banks and then start lending. Of course, if all the banks reason so, the recession will be longer and deeper than it otherwise would be. What's the alternative? Sweden (and several other countries) have shown that there is an alternative -- the government takes over those banks that cannot assemble enough capital through private sources to survive without government assistance. It is standard practice to shut down banks failing to meet basic requirements on capital, but we almost certainly have been too gentle in enforcing these requirements. (There has been too little transparency in this and every other aspect of government intervention in the financial system.) To be sure, shareholders and bondholders will lose out, but their gains under the current regime come at the expense of taxpayers. In the good years, they were rewarded for their risk taking. Ownership cannot be a one-sided bet.

Of course, most of the employees will remain, and even much of the management. What then is the difference? The difference is that now, the incentives of the banks can be aligned better with those of the country. And it is in the national interest that prudent lending be restarted. There are several other marked advantages. One of the problems today is that the banks potentially owe large amounts to each other (through complicated derivatives). With government owning many of the banks, sorting through those obligations ("netting them out," in the jargon) will be far easier. Inevitably, American taxpayers are going to pick up much of the tab for the banks' failures. The question facing us is, to what extent do we participate in the upside return?

Eventually, America's economy will recover. Eventually, our financial sector will be functioning -- and profitable -- once again, though hopefully, it will focus its attention more on doing what it is supposed to do. When things turn around, we can once again privatize the now-failed banks, and the returns we get can help write down the massive increase in the national debt that has been brought upon us by our financial markets. We are moving in unchartered waters. No one can be sure what will work. But long-standing economic principles can help guide us. Incentives matter. The long-run fiscal position of the U.S. matters. And it is important to restart prudent lending as fast as possible. Most of the ways currently being discussed for squaring this circle fail to do so. There is an alternative. We should begin to consider it.

Swiss central bankers are on a collision course with foreign-exchange traders, threatening to rein in the franc after the currency rose the most ever against the euro in 2008. Credit Suisse Group AG predicts the franc will climb 2.6 percent this quarter. BNP Paribas SA, the most accurate currency forecaster in a 2007 Bloomberg survey, and Royal Bank of Scotland Group Plc say it will rise 4 percent by mid-year --even after Swiss National Bank Vice President Philipp Hildebrand said last week that policy makers may sell "unlimited amounts of francs" to curb the gains. "The SNB on its own can’t stop it if the market wants to push" the franc higher, said Henrik Gullberg, a strategist in London at Deutsche Bank AG, the world’s largest currency trader. The central bank is probably sending "an early signal" and won’t intervene until the franc strengthens to about 1.4000 per euro, he said. Gullberg predicts 1.4650 by mid-year. The currency was last quoted at 1.5055 versus the euro, from 1.4962 on Jan. 23, and 1.1472 per dollar from 1.1542.

The franc surged 6.1 percent against the dollar and 10.8 percent versus the euro in 2008 as investors sought refuge from the global financial crisis. Switzerland has a trade surplus and doesn’t have to increase debt sales as much as other nations with a deficit. It’s also perceived as a haven from a global slump in equities, which pushed the MSCI World Index of stocks down a record 42 percent last year. Zurich-based SNB hasn’t intervened in foreign-exchange markets to influence prices by purchasing or selling currencies since the mid-1990s. The last time policy makers from one of the Group of 10 industrialized nations acted to weaken a currency was when the Bank of Japan sold 35.2 trillion yen ($390 billion) in 2003 and 2004. Instead of falling, the yen strengthened about 6 percent against the dollar in the year after sales ended. Threats to intervene come as SNB President Jean-Pierre Roth prepares to welcome central bankers, political leaders and corporate chiefs to Davos, Switzerland, for discussions on reviving the global economy at the World Economic Forum Jan. 28- Feb. 1.

The worldwide downturn, triggered by a freezing of credit markets that resulted in writedowns and losses at financial companies totaling $1.05 trillion, forced central banks from the U.S. to New Zealand to reduce interest rates. That cut profits in half from so-called carry trades, where investors borrow in countries with low rates and invest in nations with higher borrowing costs, according to data compiled by Bloomberg. Francs and Japanese yen were among the favorites for traders, who used the currencies to buy New Zealand and Australian dollars with interest rates as much as 7.75 percentage points higher. Switzerland’s trade surplus, at 8 percent of gross domestic product last year, was also a lure. The U.S., Australia and New Zealand had deficits of 4.9 percent, 5.1 percent and 9.5 percent, respectively, according to the Organization for Economic Cooperation and Development. Trade-surplus countries are perceived as safer because governments don’t have to borrow as much money in a year when sovereign bond sales are likely to exceed $3 trillion.

The franc strengthened against every major currency except the yen in 2008 as investors reduced risks. Gold climbed 5.8 percent and Treasuries earned 8.9 percent, according to Merrill Lynch & Co.’s Treasury Master Index. While the franc weakened 0.4 percent against the euro in January, last year’s gains were the most since Europe adopted the common currency in 1999. The 16-nation euro region accounts for more than 50 percent of Swiss exports, making it the country’s main trading partner. The franc’s rise prompted Hildebrand to say Jan. 21 that officials may intervene to bolster exports and head off deflation. Fellow policy maker Thomas Jordan said Jan. 15 the SNB has "no explicit pain threshold" on the franc as it watches the gains "very closely." "Deflation is just as undesirable as inflation," Hildebrand said in St. Gallen, Switzerland. "In today’s environment, one could ask whether it wouldn’t be better to aim for a higher inflation rate in order to avoid deflation at any cost." The central bank may set a fixed rate for the currency, he said. Swiss inflation, which slowed to 0.7 percent last month, may turn negative as soon as the middle of this year as the currency strengthens, the central bank estimates.

A slump in exports, which make up more than half the economy, is being exacerbated by the currency’s gains. Sales abroad fell 11 percent in November and may drop 2.6 percent this year, the government said Dec. 16. Basel-based Straumann Holding AG, the world’s second-largest dental-implant maker, said Jan. 16 revenue dropped 3 percent in the fourth quarter because of the franc’s strength. On Jan. 20, Dierikon-based Komax Holding AG, the world’s biggest maker of wire-processing machines, blamed foreign-exchange fluctuations for a 2 percent decline in sales in 2008. "A further appreciation of the Swiss franc against the euro is a big problem," said Rudolf Minsch, chief economist at Economiesuisse, a Zurich-based business-lobby and industry group. "If you see a gradual appreciation during the course of months or years, then companies can adjust. But when the rate jumps sharply in a short time, companies can’t adjust." Swings in the franc more than doubled last year. An index of volatility peaked at 19.3 on Oct. 27, when the franc hit 1.44 per euro. The index was at 13.4 at the end of last week and averaged 8.1 over the past 12 months.

The franc is rising even as the credit crisis dents earnings at Switzerland’s two largest banks. UBS AG may post a 15.5 billion-franc ($13.4 billion) loss for last year, and Credit Suisse may report a net loss of 4.2 billion francs in the same period, according to analysts surveyed by Bloomberg. A showdown with the SNB may be risky for franc bulls, said Zurich-based UBS, the world’s second-largest currency trader. "Having a central bank against you can prove costly," said Reto Huenerwadel, a senior economist in Zurich at UBS. Betting against the SNB is "brave to the degree of being foolhardy," he said, and predicted the franc will weaken to 1.54 per euro by mid-year. The SNB may not be able to revive the $416 billion economy just by weakening the franc, according to Claude Maurer, a Zurich-based economist at Credit Suisse. "People are demanding stimulus programs," Maurer said. Devaluing the franc "is a logical stimulus for the export industry, but it doesn’t do much when demand is weak."

Switzerland’s economy will contract 0.2 percent this year after expanding 1.9 percent in 2008, the OECD said Nov. 25. The euro-region economy will shrink 0.6 percent, compared with 1 percent expansion in 2008, the OECD said. Policy makers lowered the Swiss three-month London interbank offered rate, or Libor, target rate to 0.5 percent on Dec. 11, compared with 2 percent in the euro region, and a benchmark rate of 0.1 percent in Japan. The Federal Reserve maintains a range of zero to 0.25 percent. "The SNB will be watching the euro-land economy," said Paul Robson, a Royal Bank of Scotland foreign-exchange strategist in London. "Growth in euro-land is falling off really quickly. You don’t want the double whammy of falling external growth and a strong exchange rate." Investors are drawn to the franc in times of international tension and economic upheaval because of the country’s history of neutrality and political stability. The currency surged 3 percent in the 10 days after the Sept. 11, 2001, terrorist attacks on the U.S., and more than 1 percent immediately after the Madrid train- station bombings on March 11, 2004.

"The franc is always prone to strengthen in crises," said Janwillem Acket, the chief economist at Bank Julius Baer in Zurich. "It’s going to lose some of its current strength as the crisis calms down." Trading in franc options as measured by the so-called risk- reversal rate, an indicator of foreign-exchange market sentiment, shows investors are more bullish on the franc against the euro than any currency except the yen over the next year. "We’re likely to see further verbal intervention from the Swiss authorities," said Ian Stannard, a currency strategist in London at BNP Paribas. "I wouldn’t be surprised if they started to step that up. The boy-who-cried-wolf syndrome is one risk. They have used verbal intervention on various occasions without following it up with physical intervention." The central bank cut its main interest rate four times since early October, reducing it to a four-year low. The franc gained more than 4 percent against the euro even after the rate was reduced to 0.5 percent on Dec. 11.

With rates already near zero, the SNB said it may buy government and corporate bonds or offer cheaper money for longer terms. The euro fell in two of the past three weeks versus the franc amid concern governments in the 16-nation currency region will increase borrowing to records. Euro nations plan to sell about $1.1 trillion of debt in 2009, according to Royal Bank of Scotland. Switzerland plans to issue about 6 billion francs in bonds this year, compared with 5 billion francs in 2008, according to the SNB. The yield on the benchmark 10-year Swiss bond is forecast to climb to 2.45 percent by mid-year, from 2.17 percent, while the cost of borrowing in the euro region, as measured by the German 10-year yield, will be 2.87 percent, down from 3.24 percent, according to Bloomberg surveys. "We don’t think the franc’s status as a safe haven is under threat," said Marcus Hettinger, head of foreign-exchange research in Zurich at Credit Suisse. "We expect more upside for the franc this year. The euro is overvalued."

The Japanese government threw a $16.7bn lifeline to companies threatened by the global financial crisis on Tuesday, to try to shield the shrinking economy from more job losses and bankruptcies. Japanese state banks will buy shares in non-financial companies threatened by collapsing demand and frozen credit markets, the government said, adding to efforts by the Bank of Japan to make funds available by buying corporate debt from lenders. The government share buying would support small- and medium-sized firms, which employ 70 per cent of Japan’s workforce and are critical suppliers to the major manufacturers at the heart of Japan’s economy, although big firms are also not ruled out. Confirmation of the capital injection scheme pushed Japanese stocks higher, taking the Nikkei share average’s gains for the day to 4.9 per cent, but dragged on already falling bonds and the yen. "This is a plus in that it should help ease that funding squeeze," said Soichiro Monji, chief strategist at fund manager Daiwa SB Investments.

Japan is following in the footsteps of the United States and Europe, which have also gone beyond banks to bail out their auto sectors on the argument that the credit crunch threatens firms by removing their access to cash. While larger companies are more likely to benefit from the BOJ’s bond and commercial paper purchases, the latest government cash injections will provide a lifeline for small- and medium-sized enterprises, which are finding it much harder than big corporates to raise funds in the credit crunch. While individually small, such firms are crucial suppliers to big brand manufacturers such as Honda Motor Co, which announced further production cuts on Tuesday. These suppliers have been hit hard by sliding demand for Japan’s cars, technology and other exports has seen industrial production slide at a record pace, with no sign yet of a turnaround. "We want to support companies that we think are important for Japan and for regional economies, regardless of their size," said Economy, Trade and Industry Minister Toshihiro Nikai.

Japanese bankruptcies jumped 24 per cent in December from a year earlier and there were 33 among listed firms last year -- the highest annual tally in at least 60 years. The government capital will be provided through its affiliated banks buying shares in both listed and unlisted companies, the Ministry of Economy, Trade and Industry said. The ministry had set aside 1,500bn yen ($16.7bn) to cover any losses that result, an official said. The money would only go to firms facing difficulty in fund-raising due to market turmoil, and those receiving the funds will be required to draw up plans to boost profitability within three years, the ministry said in a statement. "We’re not specifying any sectors. Our ministry looks at manufacturers and companies in the service sector, but firms that are in the scheme aren’t limited to the sectors that our ministry oversees," a ministry official said. The government has not yet decided what class of shares would be bought, the official said, although Japanese media said at the weekend it would likely be through non-voting preferred stock. Tokyo’s benchmark Nikkei share average had already risen more than 3 per cent before the announcement as a weaker yen boosted shares in Japan’s key exporters.

A trader for a European bank said the news could bolster risk appetite for investors, boosting stocks but hurting the yen, widely seen as a safe haven when the outlook is bleak. But others questioned the extent of the impact. "This will be positive, but it’s hard to say how much -- after all, the details came out in news reports at the weekend," said Noritsugu Hirakawa, a strategist at Okasan Securities. The dollar rose 0.5 per cent to 89.57 yen after the announcement and the euro climbed 0.9 per cent to 118.50 yen while 10-year government bond futures extended losses to more than half a point. "I think we might see some speculative moves to buy shares and sell the yen, but it is unclear just how much such an injection of public funds would support the economy," said Tohru Sasaki, chief foreign exchange strategist at JPMorgan Chase Bank. "It is hard to say whether market players will start taking risks and sell the yen because of this." The scheme adds to government and Bank of Japan efforts to keep the country from sliding deeper into a recession that the central bank says could last two years. The government has mapped out a stimulus package while the central bank has cut interest rates to near zero and is planning to buy commercial paper, corporate bonds and other debt from banks to ease tightening financial conditions. Government fiscal efforts have, however, been controversial with plans to distribute 2 ,000bn yen ($22.3bn) in payouts to individuals opposed by voters and opposition parties, who argue it would do little to boost the economy.

The athletes’ village rising in Vancouver for the 2010 Winter Olympics is casting a shadow over the city’s finances. Vancouver may have to borrow C$458 million ($375 million) or more to finish the 1,100 units by November, Mayor Gregor Robertson said at a news conference this month. That would almost double the city’s debt to about C$928 million, said Stephen Ogilvie, an analyst at Standard & Poor’s in Toronto. The credit- rating company said Jan. 13 that it might cut The city took over financing of the C$1.1 billion housing complex after New York-based lender Fortress Investment Group LLC halted funding to the builder when costs ran C$125 million over budget. Taxpayers are reminded of Canada’s last Olympic-sized fiasco: The 1976 summer games in Montreal, which left Quebec with a C$1.5 billion debt that took decades to pay.

"The cost overruns are just getting ridiculous," said Laurence Giovando, 85, a retired marine scientist, walking past the village in central Vancouver. "We have too many problems in this town." The total taxpayer-funded price tag for the games is about C$5.84 billion from all levels of government, the Vancouver Sun reported Jan. 23. That tally includes C$883 million for a convention center, C$1 billion to upgrade the Sea-to-Sky highway to Whistler venues, and C$2 billion for a subway line to Vancouver’s airport. "Olympic games are just not a profit-turning enterprise," said Kevin Wamsley, an Olympic historian and former head of the International Centre for Olympic Studies at the University of Western Ontario in London. Residents of all Olympic host cities -- Turin, Salt Lake City, Atlanta and Calgary, among others -- end up subsidizing the games, he said.

In Montreal, construction delays and labor disputes plagued preparations. Taxpayers were left with the tab, mostly for the Olympic stadium, whose nickname devolved from "Big O" to "Big Owe." That debt wasn’t retired until 2006, said Sylvie Bastien, a spokeswoman for Quebec’s Olympic Installations Board. "Why the hell can’t we get people in there to do the job on time and for the correct amount of money?" said Michael Leckie, 76, a retired doctor who lives part-time in Vancouver. Olympic organizers say comparisons to Montreal are unfair because Vancouver may recoup the cost of the athletes’ housing when the waterfront residential units are sold. The games still may meet the operating budget of about C$1.6 billion, even as Canada slips into its first recession since 1992. The committee’s obligation to the village is limited to C$30 million for use during the games, said Jack Poole, chairman of the Vancouver Olympic Organizing Committee, or VANOC.

"We’ve done a lot of work to shore up areas where we think we might be challenged," John Furlong, chief executive officer of the committee, told reporters last week. "We’re roughly talking about the same scope and size" of spending. The committee approved a new budget last week that may include spending cuts and is to be released to the public this week. "Our only concern, as far as VANOC is concerned, is that the village be completed on time and be ready to receive the athletes," Poole said. Vancouver taxpayers didn’t learn until this month that they were on the hook for the cost of the housing complex. Millennium Development Corp., a private developer, was contracted to build it. "Decisions taken by the previous city government have put the city at enormous financial risk," said Robertson, 44, who was elected in November. "We were told in 2006 by our elected leaders at the time that the Olympic village would be developed at, and I quote, ‘no risk to the taxpayers.’"

In September 2007, the city promised Fortress Investment that it would guarantee completion of the project if Vancouver- based Millennium couldn’t, Robertson said. A year later, after cost overruns and weakening real estate prices, Vancouver was forced to step in when Fortress halted the flow of funds to Millennium, Robertson said. Former Mayor Sam Sullivan didn’t respond to an e-mailed request for comment forwarded through his former chief of staff, Daniel Fontaine. Lilly Donohue, a spokeswoman for New York-based Fortress, declined to comment. Richard Gilhooley, a spokesman with National Public Relations, said Millennium executives declined to comment. A second athletes’ village is being built by the town of Whistler, which will host events such as alpine skiing, bobsleigh and luge during the games Feb. 12-28.

Vancouver taxpayers’ liability will depend on how much the housing units fetch when they’re sold, Robertson said. The average home price in metropolitan Vancouver is down 15 percent from May, according to the Real Estate Board of Greater Vancouver. Poole said it’s only a matter of time before demand for real estate recovers, which will eliminate taxpayers’ exposure. "This is a billion-dollar asset that’s going to be sold into the retail market and recover all that capital plus a profit," he said. For Giovando, the Vancouver taxpayer, the games’ costs will be measured in more than just money. "It’s just plain embarrassing for our city, the province and our country," he said. "But mostly for our city."

Iceland's center-left Social Democratic Alliance Party was chosen Tuesday to lead the country following the collapse of the island nation's government amid deep economic troubles and intense political discord. President Olafur Ragnar Grimsson, who largely serves in a symbolic role, said he asked Alliance leader Ingibjorg Gisladottir to form a new coalition government with the Left-Green movement following crisis talks with Iceland's five political parties. Iceland's previous coalition government fell apart Monday when Prime Minister Geir Haarde, who led since 2006, was toppled by angry protests over the country's slide into economic ruin. The new government will likely remain in place until May, when early national elections are expected. Gisladottir, who last week had surgery on a brain tumor, said she will likely appoint Social Affairs Minister Johanna Sigurdardottir as interim prime minister. "We have taken the baton -- the government should be operational before the weekend," Gisladottir told reporters at the president's residence.

Haarde's government was sunk after Iceland's banks collapsed last year with huge debts amassed during years of rapid expansion. Unemployment and inflation have spiraled and the International Monetary Fund predicts Iceland's economy will shrink by about 10 percent in 2009, which would be its biggest slump since Iceland won full independence from Denmark in 1944. Since the global credit crunch hit, Haarde has nationalized banks and negotiated about $10 billion in bailout loans from the IMF and individual countries. But his government has come under sharp criticism for failing to adequately oversee Iceland's banking system and protecting the once-prosperous nation of 320,000 people. "We have been given this job, and we'll do our best in a difficult situation," said Steingrimur Sigfusson, chairman of the Left-Green movement. Government posts will be shared between the two parties in the coming days, he said. Haarde said last week he won't lead his conservative Independence Party into the May elections -- moved up from 2011 -- because he needs treatment for throat cancer. Thousands of angry Icelanders have demonstrated against the ousted government in recent weeks, clattering pots and kitchen utensils in what some commentators have called the "Saucepan Revolution." Though largely peaceful, protesters have doused Reykjavik's parliament building in paint and hurled eggs at Haarde's limousine. Last Thursday, police used tear gas to quell a protest for the first time since 1949.

2009 is set to be an historically difficult year for Danish exports to core markets. The sale of goods to Denmark's core export markets has dropped drastically over the past year and industry and the Danish Export Council are expecting 2009 to be the most difficult year ever. Politiken has surveyed the latest export figures for Sweden, Norway, Great Britain, the United States and Germany for November 2008 and compared them with figures for November 2007. The tendency is clear - with the exception of Germany, Danish exports to these countries have fallen dramatically from 2007 to 2008. In the case of the U.S., Great Britain and Sweden, the drop is much greater than the average drop in exports. The drop in exports to Sweden, for example, between November 2007 and November 2008 was at 22 percent. The corresponding figure for the U.S. was a drop of 32 percent. "The overall picture is that several of the biggest export markets have been hit by the worst possible combinaton of falling demand and exchange rates falling in relation to the Danish krone," says Denmark Export Council Chief Economist Jacob Warburg.

The worst prospects are said to be for the United Kingdom. Exports to the U.K. have dropped 12 percent over the past year and the council expects negative British GDP in both 2009 and 2010. The Confederation of Danish Industries (DI) expects Germany, which is Denmark's largest export market, to be even harder hit than Britain. "This in particular because the German car industry has been hit hard as a result of the crisis," says DI Chief Economist Klaus Rasmussen. The Export Council says that countries such as Turkey, Poland, India, Egypt and Saudi Arabia are among the countries that will be least affected by the crisis and as such are markets that Danish export companies should be more interested in. Forecasts suggest that all of these countries will experience GDP growth in coming years, despite the crisis.

For Europeans, last week’s resumption of Russian natural gas shipments ended a two-week energy dispute. For Ukraine, it may have ended any hope of weathering the global financial crisis. The accord with Russia will increase Ukraine’s spending on gas by almost 7 percent, to $9.16 billion, at a time when soaring bond yields are raising the specter of default. Already, Ukraine is living on the first installment of a $16.4 billion bailout from the International Monetary Fund. Further payouts will depend on whether the country balances its 2009 budget, cancels a tax on foreign exchange and strengthens banking laws.

Ukraine hasn’t been so fragile since the early 1990s, following the breakup of the Soviet Union. The economy may shrink as much as 10 percent this year, which would be the deepest recession in Europe except for Iceland’s. President Viktor Yushchenko’s support is close to zero and clashes with Prime Minister Yulia Timoshenko may bring down the government. "The country is staring into the abyss, both politically and economically," said Neil Shearing, an analyst at London-based Capital Economics Ltd. "I can’t think of another country that will be hit harder this year" in eastern Europe. The 2004 Orange Revolution, which brought Yushchenko and Timoshenko to power when both favored joining the European Union and the North Atlantic Treaty Organization, seems far away.

A promise of EU membership hasn’t been offered, and NATO ruled out near-term entry for Ukraine and Georgia last December, though support for Ukraine in the longer term would keep the region stable, said Czech Deputy Prime Minister Petr Necas, whose country holds the EU’s six-month rotating presidency. "We are interested in having a stable and economically prosperous Ukraine," Necas said in an e-mailed answer to a Bloomberg question yesterday. "Ukrainian workers undoubtedly contribute to the economic growth in the Czech Republic and we do not regard them as a threat." The outcome of the energy controversy has strengthened Russian Prime Minister Vladimir Putin, 56, who said on Jan. 8 that Ukraine’s leadership was "highly criminalized." Over time, Ukraine’s income from transit fees for natural gas may be jeopardized as Europe seeks or builds more stable supply routes.

The dispute with Russia that left Ukraine and other eastern European countries without gas is only the latest in a series of events that brought the country to the brink of collapse. Global steel prices have fallen 50 percent since a record in July, hurting the country’s largest export and cutting sales for VAT ArcelorMittal Kryvyi Rih and Metinvest BV. The higher gas costs will deepen this year’s expected contraction. Gross domestic product will shrink as much as 10 percent, according to Shearing, and 9 percent based on HSBC Holdings Ltd. forecasts. Yields on Ukraine’s $105.4 billion of government and company debt, now at 25.67 percent, are the highest of any country with dollar-denominated debt except Ecuador, which defaulted in December.

The gross foreign debt includes direct state debt, including loans from the IMF, the European Bank for Reconstruction and Development; domestic Treasuries owned by foreigners; bank borrowing, including bonds and loans; and corporate debt, including bonds and loans. The Ukrainian currency, the hryvnia, has lost 38 percent in the past year against the dollar and the benchmark stock index has plunged 75 percent. Like fellow Russian gas customers Bulgaria and Slovakia, Ukraine failed to diversify its power sources or budget for a gas- price increase that Russia has been trying to impose since Yushchenko took office at the beginning of 2005. The agreement between Russian gas exporter OAO Gazprom and NAK Naftogaz Ukrainy will make Ukraine pay market prices starting next year.

The bickering between Yushchenko, 54, and Timoshenko, 48, has gone on since they began sharing power, crippling the government’s ability to pass legislation to strengthen the banking and economic systems and sell unprofitable state assets."You can start by putting the Ukrainian government on the stand," said Fredrik Erixon, director of the Brussels-based European Centre for International Political Economy. "One can blame other factors, but the simple fact is you can avoid the situation you have seen in Ukraine with better policies." A Dec. 17-28 survey conducted by the Kiev-based Democratic Initiatives Foundation showed that 84 percent of respondents believed the country was moving in the wrong direction even before the gas crisis started. That compares with 48.6 percent in 2007. The poll of 2,012 people had a margin of error of 2.2 percent.

The poll also found that if presidential elections scheduled for January 2010 were held today, 22.3 percent would support former Prime Minister Viktor Yanukovych, the pro-Russian opposition leader. Another 13.9 percent would pick Timoshenko and 2.4 percent would choose Yushchenko. Almost half said no politician could deal with the financial and economic crises. "The government was not ready to meet such obvious worldwide financial threats and currently is not able to protect Ukrainians," said Oleksandr Slobodyanyk, 27, who lost his job more than two months ago as a broker at Concorde Capital in Kiev. "I see no other option but to look for a job abroad." The government broke down in October after Timoshenko joined the opposition in stripping the president of some powers. Plans for early elections on Dec. 14 were later dropped after the two leaders re-formed the Cabinet and promised to work together.

Now, Yushchenko blames Timoshenko -- who went to Moscow and negotiated with Putin -- for giving in too far to Russian demands. She is trying to oust central bank Governor Volodymyr Stelmakh, an ally of Yushchenko’s. Former Soviet republics Latvia and Lithuania to the north experienced rioting this month because of anger over government failure to limit the effect of the financial meltdown. "Ukrainians, generally speaking, have had enough of the government," said Tanya Costello, the London director for New York-based Eurasia Group. "I don’t think there is a political leader in whom the public has its trust at the moment. So it’s more likely you will see pockets of social unrest."

Following Treasury Secretary designee Tim Geithner's public confirmation hearing, an extensive Q & A occurred in writing. We have posted a copy of the US Senate Finance Committee's 100-page text on our website. See: http://www.cumber.com/special/geithnerquestions2009.pdf. This is must reading for any serious investor, economist, strategist, analyst, or observer. In this text you will find what is on the minds of the Senators, and you will gain insight into the policies that will be forthcoming from the Obama administration. One telling example is found in the following quote that has already created international consternation. Geithner twice answered questions about currency and China. In so doing he has placed the Obama administration squarely in the middle of the tension between the United States and the largest international buyer and holder of US debt: China.

This happened as the same Obama administration is unveiling a package that will add to the TARP financing needs and the cyclical deficit financing needs and cause the United States to borrow about $2 trillion this year. Two trillion dollars of newly issued Treasury debt -- and this is how the question was answered. Not once but twice. Geithner (on page 81 and again on page 95) answered: "President Obama -- backed by the conclusions of a broad range of economists -- believes that China is manipulating its currency. President Obama has pledged as President to use aggressively all the diplomatic avenues open to him to seek change in China's currency practices." "Manipulation?" "Aggressively?" This is strong language. Geithner did not do this on his own authority. These are prepared answers. He is citing the new President, not once but twice.

China's response was fast and direct. China's commerce ministry said in Beijing that China "has never used so-called currency manipulation to gain benefits in its international trade. Directing unsubstantiated criticism at China on the exchange-rate issue will only help US protectionism and will not help towards a real solution to the issue." Are we seeing the world's largest and third largest economies calling each other names in the middle of a global economic and financial meltdown? The world is in recession. The economic growth rates in the major and mature economies are now negative numbers. In China the growth rate is at least 4 and maybe as much as 8 points below last year. All the governments of the world that are running deficits are enlarging them in order to finance stimulus packages. Their central banks are bringing the policy interest rates toward zero. Trillions will need to be borrowed by those governments. Either they will be financed by the outright massive printing of money through the central bank mechanism, or they will be financed by those in the world who have savings.

China is the largest single holder of financial savings in the world. Japan is next. Why are we picking a fight with China? The implied question is why are we alluding to one with Japan, whose currency is currently the strongest of the G4 majors? In a world where global finance is mostly in US dollars, British pounds, euros, and yen, this is engaging in a dangerous sport. The pound has lost one third of its value against the dollar since the crisis began. It is destined to weaken more. The euro struggles because of the structural issue of having to conduct monetary policy in the sovereign debt of the various euro zone member countries. The gap between those sovereign interest rates has reached nearly 3% between the weakest and strongest. This is an extremely difficult task for the European Central Bank to manage.

And Japan is getting killed by the flight to the strong yen. Japan will intervene soon to weaken the yen; they have as much as said so. The yen is strengthening against the Chinese Yuan; that is Japan's largest trading partner. The yen is 1.5 standard deviations above the JPY/USD exchange rate. It is nearly 3 standard deviations above the JPY/EUR cross rate that has been established during the ten years the euro existed. And it is over 3 standard deviations above the JPY/GBP cross rate. So that leaves the dollar likely to get stronger. Right now it is the default choice of the world. We have currency strength not because we are so desirable but because we are currently better than the others. All bad; we're not as bad as they are. Or all bad and the others are even worse.

So what do we do within 72 hours of launching the Obama administration that says it is seeking "change?" We fire the first public salvo in what could easily become a trade war or a threat to global financial integration. What makes us so credible? Is it our proven record of regulatory oversight of our financial markets, as demonstrated by the Madoff scandal and the SEC? Is it the way our rating agencies work so diligently to place a coveted "AAA" on paper that was peddled to the rest of the world and was found out to be highly toxic? Is it the way we honor the promises of federal agencies by having tier-one-eligible Fannie and Freddie preferred held in the US and abroad by institutions, and then essentially cause a structural default on that preferred (actually, dividend suspension)? Or is it the way the actions of Treasury and the Federal Reserve allowed a primary dealer (Lehman) to fail, thus triggering a global contagion?

C'mon? Where is the plan to restore confidence and credibility and transparency and consistent policy for the United States? And how does the Obama administration believe that launching a fight with China is beneficial? In the 1930s the severe recession of 1929-1931 was turned into the depression of 1931-1933 because of protectionism. Every historian knows that. Every economist learns it in school. This is well-known by Geithner and even better-known by Larry Summers and Paul Volcker. They are the three members of the Obama economic troika. The statement Geithner repeated twice was certainly known to them in advance. Why did they not temper it? What is the plan? Do they want to threaten and see if China backs down? This, too, is dangerous. Do they intend to pursue the Schumer tariff scheme? There are more questions than answers. Lastly, Larry Summers was going to attend the World Economic Forum in Davos, Switzerland. He has cancelled. Why? Was it because he did not want to have to face the private conversations that would follow such statements as have been made by Geithner in the name of the President?

Watch Davos closely. And remember that the absence of statements is as revealing, if not more so, than the presence of them. Not one mention of trade openness appears in our reading of the 100 pages of answers to the Senate. Maybe someone else can find an affirmation of free and open trade. I cannot. We fear protectionism. It starts with rhetoric. We now have that threat. If it is pursued, it ends badly for everyone. No one wins. Geithner's answers are sobering. We are now in the realm of fiscal policy and national policy. This is not in the realm of the central bank; the Federal Reserve is not the player here. The Fed is doing all it can to unfreeze the financial system and restore it to functionality. If permitted to complete its task, that policy will work. If stymied or corrupted by conflicting policy in trade or federal finance, the recession will worsen and the pain will become more severe.

Back in February 2008, we at RGE Monitor warned that that the credit losses of this financial crisis would amount to at least $1 trillion and most likely closer to $2 trillion. At that time such estimates were derided as being exaggerated as the market consensus at that time was around $200-300 billion of subprime mortgage related losses. But we pointed out that losses were not limited to subprime mortgages and would rapidly mount -- following a severe US and global recession -- to near prime and prime mortgages, commercial real estate loans, credit card loans, auto loans, student loans, leveraged loans, muni bonds, industrial and commercial loans, loans to real estate developers and contractors, corporate bonds, CDS and the securities (MBS, CDOs, CMOs, CPDOs, and the entire alphabet soup of derivative instruments) that -- via securitization -- represented claims on these underlying loans.

Soon enough, market estimates of loan and securities losses mounted: by April 2008 the IMF estimated them to be $945 billion; then Goldman Sachs came with an estimate of $1.1 trillion; the hedge fund manager John Paulson estimated them at $1.3 trillion; then in the fall of 2008 the IMF increased its estimate to $1.4 trillion; Bridgewater Associates came with an estimate of $1.6 trillion; and most recently, in December 2008, Goldman Sachs cites some estimates close to $2 trillion (and argues that loan losses alone may be as high as $1.6 trillion and expects a further $1.1 trillion of loan losses ahead). In mid-November 2008, the threshold of $1 trillion in global financial writedowns was finally reached. Thus, as we argued throughout 2008, our $1 trillion estimate was only a floor - not a ceiling - for eventual losses and our upper range of $2 trillion would become more likely.

We have now revised our estimates and we now expect that total loan losses for loans originated by U.S. financial institutions will peak at up to $1.6 trillion out of $12.37 trillion loans . Our estimates assume that national house prices will fall another 20% before they bottom out some time in 2010 and that the unemployment rate will peak at 9%. If we include then around $2 trillion mark-to-market losses of securitized assets based on market prices as of December 2008 (out of $10.84 trillion in securities), total losses on the loans and securities originated by the U.S. financial system amount to a figure close to $3.6 trillion. U.S. banks and broker dealers are estimated to incur about half of these losses, or $1.8 trillion ($1 -1.1 trillion loan losses and $600-700bn in securities writedowns) as 40% of securitizations are assumed to be held abroad. The $1.8 trillion figure compares to banks and broker dealers capital of $1.4 trillion as of Q3 of 2008, leaving the banking system borderline insolvent even if writedowns on securitizations are excluded.

Arguably, mark-to-market losses on private sector securitizations have so far been largely compensated for by increased activity in the government-sponsored sectors, but mark-to-market writedowns may become a more important factor going forward for bank capitalizations and credit provision to the private sector. Moreover, even assuming that securitized assets may have fallen in value excessively because of a liquidity premium -- rather than credit risk alone -- we still get very large losses. Assume -- generously -- that securities are now underpriced because of illiquidity and that market losses will be eventually 20% lower than we currently estimate because of such temporary factors. Then writedowns on market securities would be $1.6 trillion rather than $2 trillion and total credit losses would be $3.2 trillion rather than $3.6 trillion.

In this paper we argue that, in order to restore safe credit growth, the U.S. banking system thus needs an additional $1 -- 1.4 trillion in private and/or public capital. These magnitudes call for a comprehensive solution along the lines of a 'bad bank', or preferably a restructuring of the financial system through an RTC or our through our HOME proposal. Our data on outstanding loan and securities amounts are as in IMF Global Financial Stability Report, Table 1.1, as well as the weights in assigning loss shares to banks and non-bank (see data in Appendix 1).Different from the IMF which focuses on charge-offs only, we look at both charge-off and delinquency rates as we assume a high proportion of delinquent loans will turn bad in this cycle, especially as financial institutions have thin capital bases inadequate to deal with unexpected losses.

Compared to the IMF we estimate for loan losses based not on current default/ delinquencies rates but rather what those losses will be when such default and delinquencies will reach their peak some time in 2010. Our calculations are assume a further 20% fall in house prices (Case/Shiller) and unemployment peaking at 9% during this cycle as discussed in the RGE 2009 Global Economic Outlook. With respect to credit losses on unsecuritized loans, recent research by the Federal Reserve Board (Sherlund (2008)) using comparable house price assumptions (but assuming high oil prices) concludes that over half of 2006-2007 subprime mortgage originations are set to default (i.e. $150bn out of $300bn in our data). The loss trajectories for Alt-A loans are similar, resulting in a 25% default rate ($150bn out of $600bn). Even prime mortgage delinquencies display a very high correlation with subprime loan delinquencies (Doms/Furlong/Krainer (2008), implying an approximate 7% default rate when the potential for 'jingle mail' is taken into account ($266bn out of $3,800bn). Our dollar losses for the subprime and Alt-A categories (incl. RMBS) are broadly in line with similar estimates in the literature.

The cycle has also turned in the commercial real estate (CRE) area with the traditional lag of around 2 years. Current serious delinquency plus default rates of 5.9% of CRE loans (Fed data) are projected to increase to up to 17% by industry experts cited in a Fitch study referring to CMBS data and assuming a 25% fall in prices ($408bn out of $2.4 trillion.) This compares with a 1991 peak charge-off plus delinquency rate of 14.5%. In the consumer loan area, we estimate credit card charge-off rates could increase to 13% in the worst case scenario. Adding a typical 4% delinquency rate during recessions, the total loan losses on unsecuritized consumer loans are projected to increase to $238bn out of $1.4 trillion.

The IMF warned that commercial and industrial loans (C&I) losses are likely to climb to historical peaks and potentially beyond in this cycle. Compared to past C&I loan loss rates, we project charge-off and delinquencies to reach 10% or $370bn out of $3.7 trillion of unsecuritized C&I loans. With regard to leveraged loans, the latest research by Boston Consulting/IESE Business School based on the 100 largest PE firms engaged in LBOs calculates an expected book loss from default of about 30%. This translates into $51bn in losses out of $170bn unsecuritized leverage loans. Based on these calculations, RGE now expects total loan losses to the financial system to reach about $1.6 trillion out of $12.37 trillion of unsecuritized loans alone, implying an aggregate default rate of over 13%. Applying IMF weights, the U.S. banking system (commercial banks and broker dealers) carries about 60-70% of unsecuritized loan losses, or around $1.1 trillion.

Total mark-to-market (mtm) writedowns on a further $10.8 trillion of U.S. originated securities outstanding reached about $2 trillion by the end 2008 based on cash bond and derivatives prices. In particular, applying Markit ABX prices to $1.1 trillion of outstanding subprime RMBS results in a mtm loss rate of 50%, or $550bn. Markit TABX prices also show that $400 billion ABS CDOs consisting of mostly junior subprime RMBS tranches are all but worthless by now and expected to remain that way (95% or 380bn month-to-month loss.) Writedowns in the prime MBS universe are primarily driven by jumbo mortgages which we assume to trade at 97% based on the record 3% spread between the 30-year jumbo mortgage and the 10-year Treasury yield with comparable average maturity. Mtm losses on prime MBS are therefore assumed to be $114bn out of $3.8 trillion outstanding. CMBX spreads spiked up implying a month-to-month write down of about $282bn out of $940bn outstanding.

The aggregate consumer debt ABS price index across all ratings trades at 80% thus implying $130bn in month-to-month writedowns out of $650bn outstanding. The high-yield corporate debt index traded at 75% (month-to-month $150bn out of $600bn), whereas high-grade corporate debt traded at 95% before moving back to 100%: we assume a writedown of $190bn out of $3.8 trillion. Derivatives indices for securitized leveraged loans implied a month-to-month loss of 123bn by the end of 2008 out of $350bn in CLOs outstanding. Flow of funds data show that 40% of U.S. originated securitizations are held abroad, leaving U.S. institutions with 60% of m-t-m writedowns, and U.S. banks in particular with a share of 50-60% thereof, i.e. $600 --700bn, when applying IMF weights. Expected U.S. banks loan losses of about $1.1 trillion out of a total $1.6 trillion, plus bank month-to-month writedowns of $600 - $700bn on securities based on December 2008 prices amount to about $1.8 trillion. Compared with a total bank capitalization of $1.4 trillion (incl. FDIC insured plus investment banks as of Q3), the estimated capital shortfall amounts to around $400bn in the worst case scenario before recapitalization.

(Our colleague Christopher Whalen of Institutional Risk Analytics -- one of the leading experts of U.S. banking - has long predicted that peak charge-offs for the US banking industry will reach 2x 1990 levels during 2009, which would mean 4% charge-offs against total loans and leases for all FDIC insured banks or some $800 billion in realized losses. In reviewing a draft of our paper, Chris noted that the Q4 2008 results from Citi, JPMorgan, Bank of America show that charge-offs were running at a rate roughly double 2007 levels and that he expects charge-offs for these larger banks to double again by Q2 2009 and to continue rising through the second half of 2009. He thinks that our "$1.1t loss estimate is very reasonable for the financials in terms of charge-offs". The total accumulated loss for all FDIC insured banks will depend upon how long the industry remains at this peak level of loss experience; thus, our loss estimates for U.S. banks losses could be conservative and losses may end up being much larger than we predict.

Even including the TARP 1 injection of capital of $230 billion into the banking system and the further $200 billion of capital injected by private investors and sovereign wealth funds since the start of the crisis, the overall banking system would still be borderline insolvent. Moreover, in order to restore the capital of the banking system to the previous level of $1.4 trillion (a level close to the 8% capital requirement of Basel II) an additional $1.4 trillion of private and public/government capital would have to be injected in the banking system to restore safe credit growth. If a reform of the regime of regulation of banking institutions were to argue that banks and broker dealers need more than the Basel II 8% criteria to operate safely even more than $1.4 trillion of new capital will have to be injected in the banking system.

Thus, even the release of TARP 2 (another $350 billion) and its use to recapitalize banks only would not be sufficient to restore the capital of banks and broker dealers to internationally accepted capital ratios. A TARP 3 and 4 of up to $1.05 trillion (assuming generously that all of TARP 2 goes to banks and broker dealers) may be needed to restore capital ratios to adequate levels. Even assuming that private and foreign capital would contribute to 50% of this additional required recapitalization an additional TARP 3-4 of $560 billion may be needed in the form of public capital injections in banks and broker dealers alone. This would leave out the insurance companies, finance companies and other financial institutions (the GMAC, GE Capital, etc.) which may also need further public capital. Our estimates may turn out to be too pessimistic as the current illiquidity premium in prices of securities may disappear over time and a faster than expected growth recovery may reduce the expected losses on loans. But even in that case the current shortfall of capital in the banking system would be close to a staggering $1 trillion rather than an even bigger $1.4 trillion.

Conversely, credit losses may turn out to be even larger than we estimate: if instead of a U-shaped recession that is over by the end of 2009, the US recession were to last well into 2010 and turn out to be a Japanese style L-shaped recession, total loan and especially securities losses would end up being much larger than our benchmark of $3.6 trillion, potentially as high as $5 trillion. Thus, the release of TARP 2 is welcome news for the banking sector but the prospect of further month-to-month losses and feedback loops that are not yet priced in calls for a more comprehensive solution for toxic assets along the lines of the proposed 'aggregator bank' or preferably an outright restructuring of the banking system a la RTC. Moreover, in order to address the root causes of the financial crisis in the mortgage and the household sectors, we proposed recently the "HOME (Home Owners' Mortgage Enterprise): A 10 Step Plan to Resolve the Financial Crisis" that includes an RTC to deal with toxic assets, a HOLC to reduce homeowner mortgage debt, and an RFC to refinance viable banking institutions. The US banking system is borderline insolvent in the aggregate and it will take a huge amount of public financial resources and complex and time-consuming work-out of insolvent institutions to restore its financial health and allow it to lend again in ways that support sustained economic growth.

Six years ago, Peter Orszag, President Obama's new budget director, co-authored a Brookings Institution study that concluded: "Balancing the budget would require a 41% cut in spending on Social Security and Medicare, a 47% cut in discretionary spending, or a 17% cut in all non-interest spending." It's getting worse: Today entitlements eat up 40% of the federal budget and are growing. No doubt Orszag's earlier thinking had a lot to do with why Obama picked him. But it's also a signal of what we can expect when a Social Security reform bill is sent to Congress during Obama's "first 100 days." And that will trigger a brutal battle. Why? Because AARP's 35 million members will fight all benefits reductions while young voters who put Obama in office will fight any new Social Security taxes.

Bruising battle? It won't matter. In the long term, reforming entitlements will be like rearranging deck chairs on the Titanic. Remember, Obama's adding a $1 trillion stimulus package on top of what Nobel economist Joseph Stiglitz calls a "$10 trillion hangover" of debt left by former President Bush and the economic meltdown. And all that's on top of the massive $60 trillion to $75 trillion of unfunded Social Security and Medicare liabilities. To get perspective, let's shift our thinking into a parallel universe: Into Chris Buckley's satirical novel "Boomsday," which goes way beyond acceptable government policies. He offers a bizarre solution to reforming Social Security, a solution that forces all of us to focus, and not just on the out-of-control economics of retirement entitlements. He forces us to focus on the one core problem overshadowing all other global economic issues: Population growth.

Yes, population is the core problem that, unless confronted and dealt with, will render all solutions to all other problems irrelevant. Population is the one variable in an economic equation that impacts, aggravates, irritates and accelerates all other problems. Imagine you're on a call with the Oval Office:

"Listen to me," the frustrated U.S. president says on the phone in "Boomsday:" "I got a collapsing economy. I'm fighting four wars -- and looks like another is on the way." Agitated. "I got melting ice caps on both poles. Florida just lost another two feet of waterfront. Hundred square miles of Mississippi just went under." Faster. "I got a drought in the West the Interior Department says is going to make Colorado and Wyoming into another dust bowl." Breathless. "Pakistan and India are going at each other like a couple of wet cats. The CIA's telling me Israel's preparing to launch nuclear weapons." He's shaking. "I don't have time to take on a one-legged senator who says the solution to Social Security is for us to kill ourselves at age 70. The way I'm feeling now, I may shoot myself. And I may not wait until I'm 70."

Yes, you heard right. He's reacting to a proposal made by Cassandra Devine, a character in "Boomsday." She's a young, hot PR hustler running a "must read" blog. She resents the fact that her generation is getting stuck with the tax bill to pay Social Security benefits for retiring boomers. At first, her proposal was just a wake-up call, a shocker to get attention, to get Washington to deal with a hot-button issue politicians refuse to face. Her plan: Reduce population by encouraging suicides for aging boomers.

OK, so suicide's a bizarre, unacceptable solution. But "Boomsday" does put the problem in sharp focus: No, it's not "peak oil." Not global warming. It's the population explosion: Too many people, old and young, boomers and babies too. More and more people filling up our little planet. And while she proposes eliminating boomers, throughout history other writers, warriors and governments have dealt with the other end, limiting births -- from family planning, infanticide, even genocide. Yet few expect change at either end of this spectrum. Indeed, a United Nation's study estimates the world population will continue exploding, from 6.6 billion to 9.3 billion by 2050!

And not only will there be about 50% more people on the planet before today's kids reach the age of the youngest boomers today, but every year they'll also be demanding more opportunities, more benefits and more resources for their personal economic growth as well as for the expansion of their national economies. Warning: by 2050 America's 400 million will be vastly outnumbered by 8.9 billion others across the planet, all competing with America. In short, within four decades human demands will easily double. That makes population growth the key variable in every economic equation ... impacting every other major issue facing world economies ... from peak oil to global warming ... from foreign policy to nuclear threats ... from religion to science ... everything. Population is the No. 1 variable in the economic equation. And here's how an exploding population will remain the key variable driving all other major economic issues in the next four short decades:

Global wars ... over food, water and energy Five years ago Fortune reported on "The Pentagon's Weather Nightmare." Yes, from inside our military comes a warning of "the mother of all national security issues." As "the planet's carrying capacity shrinks, an ancient pattern reemerges: the eruption of desperate all-out wars over food, water, and energy supplies." But ask yourself: What if nations prioritized population control policies to minimize growth and reduce demand?

'Global warming' ... and nuclear threats Will it work? In the latest Foreign Policy magazine, environmental economist Bill McKibben, author of "The End of Nature," warns: "It might already be too late ... to save the planet from a climate catastrophe." The International Energy Agency's answer is more supply to feed exploding demand: The world must spend "$45 trillion to build 1,400 nuclear power plants and vastly expand wind power" in order to "halve greenhouse gas emissions by 2050." Their supply-side obsession assumes three billion more people. But what if we focused on cutting demand by stabilizing world population at 6 billion?

'Peak oil' ... versus 'peak population'Experts warn that "The Age of Oil" is over. Soon the marginal cost of extracting a barrel will equal the sale price. We are on the downside of the bell curve. Special interests like Exxon-Mobil and the Saudis disagree. But check sites like LifeAftertheOilCrash.com: "Civilization as we know it is coming to an end soon. This is not the wacky proclamation of a doomsday cult, apocalypse bible prophecy sect, or conspiracy theory society. Rather, it is the scientific conclusion of the best paid, most widely respected geologists, physicists, bankers and investors in the world. These are rational, professional, conservative individuals who are absolutely terrified by a phenomenon known as global 'peak oil.'" Warning: We're near the tipping point: Stabilize population or self-destruct.

Alternative energies, 'political will' and lobbyists Wall Street, Washington and Corporate America hustle the myth that we must become "energy independent." History suggests narrow special-interest lobbyists will dull the "political will to act" till we pass the point of no return. Our population will grow from 300 million to 400 million by 2050, but the rest of the world will add another 3 billion, with all demanding more economic resources to meet burgeoning demands for energy, food and water. If the world's population isn't addressed, we'll be outnumbered and outgunned.

The mythological math of 'economic growth'

Economic equations stumble on bogus data. Last spring political historian Kevin Phillips wrote a brilliant Harper's article "Numbers Racket" warning us that "the economy is worse than we know." Politicians use "deceptive statistics" to sell "Americans that the U.S. economy is stronger, fairer, more productive, more dominant, and richer with opportunity than it really is. The corruption has tainted the very measures that most shape public perception of the economy." Making matters worse, economists are part of this conspiracy, tacitly endorsing government propaganda about progress. Evolutionary geologist Jared Diamond put all this in perspective in his Pulitzer Prize-winning "Collapse: How Societies Choose to Fail or Succeed:"

"One of the disturbing facts of history is that so many civilizations collapse. Few people, however, least of all our politicians, realize that a primary cause of the collapse of those societies has been the destruction of the natural resources on which they depend. Fewer still appreciate that many of those civilizations share a sharp curve of decline. Indeed, a society's demise may begin only a decade or two after it reaches its peak population, wealth and power."

What's the one common reason societies, cultures, nations have collapsed across the world and throughout history? Leaders "focused only on issues likely to blow up in the next 90 days," lacking the will "to make bold, courageous, anticipatory decisions." Their short-term thinking, unfortunately, sets the stage for a rapid "sharp curve of decline."

Rocked by a budget crisis, Brandeis University will close its Rose Art Museum and sell off a 6,000-object collection that includes work by such contemporary masters as Roy Lichtenstein, Andy Warhol, and Nam June Paik. The move shocked local arts leaders and drew harsh criticism from the Association of College and University Museums and Galleries. Rose Art Museum director Michael Rush declined comment this evening, saying he had just learned of the decision. Brandeis is also discussing a range of sweeping proposals to bridge a budget deficit that could be as high as $10 million, such as reducing the size of the faculty by 10 percent, increasing undergraduate enrollment by 12 percent to boost tuition revenue, and overhauling the undergraduate curriculum by eliminating individual academic programs in favor of larger, interdisciplinary divisions.

Other plans under consideration include requiring students to take one summer semester, allowing the university to expand its student body without overcrowding, and adding a business program. The changes would take place, at the earliest, in 2010. "This is not a happy day in the history of Brandeis," President Jehuda Reinharz said tonight. "The Rose is a jewel. But for the most part it’s a hidden jewel. It does not have great foot traffic and most of the great works we have, we are just not able to exhibit. We felt that, at this point given the recession and the financial crisis, we had no choice." Brandeis said the museum would be closed late this summer. It was founded in 1961; a new wing designed by celebrated architect Graham Gund was added in 2001. Announcement of the closing came as Rush was searching for a chief curator. A leading expert on video art, he had arrived in 2005 with plans to expand the museum. He also launched a full scale analysis of the museum’s value by Christie’s auction house.

Dennis Nealon, the university's director of public relations, would not say how much the collection is worth. Experts on university art collections said the move was unusual, but not unexpected. "Clearly, what’s happening with Brandeis now is that they decided the easiest way is to look around the campus and find things that can be capitalized," said David Robertson, a Northwestern University professor who is president of the Association of College and Univertsity Museums and Galleries. "It’s always art that goes first." But there is no precedent for selling an art collection of the Rose's stature. Internationally recognized, the collection is strong in American art of the 1960s and 1970s and includes works by Willem de Kooning, Jasper Johns, Morris Louis, and Helen Frankenthaler. "I’m in shock," said Mark Bessire, the recently named director of the Portland Museum Of Art. "And this is definitely not the time to be selling paintings, anyway. The market is dropping. I’m just kind of sitting here sweating because I can’t imagine Brandeis would take that step."

New York's attorney general issued a subpoena to former Merrill Lynch Chief Executive John Thain on Tuesday in a probe into bonuses paid to the firm's employees just days before its takeover by Bank of America Corp. "The fact that Merrill Lynch appears to have moved up the timetable to pay bonuses before its merger with Bank of America is troubling to say the least and warrants further investigation," Attorney General Andrew Cuomo said in a statement. Bank of America spokesman Scott Silvestri declined to comment. Cuomo said his office issued a subpoena seeking testimony from Thain, who was ousted from Bank of America on January 22. Also subpoenaed was Bank of America Chief Administrative Officer J. Steele Alphin, Cuomo said. Cuomo said his office is conducting its ongoing inquiry into executive compensation practices at companies taking part in the $700 billion financial bailout fund together with the special inspector general of the federal aid program.

House Judiciary Chair John Conyers has placed former Bush political advisor Karl Rove under subpoena. Rove is being brought before the Judiciary Committee to testify about his role in the U.S. attorneys scandal and a number of other matters, including the suspiciously political prosecution of former Alabama Governor Don E. Siegelman. His appearance date is February 2. The Associated Press reports:

"I have said many times that I will carry this investigation forward to its conclusion, whether in Congress or in court, and today’s action is an important step along the way," Conyers said. The change in administrations may affect the legal arguments available to Rove, Conyers said. "Change has come to Washington, and I hope Karl Rove is ready for it. After two years of stonewalling, it’s time for him to talk," Conyers said.

Last year, Rove defied a congressional subpoena, attending a conference with post-Soviet oligarchs in the Crimea when he was required to appear before Congress. Rove argued that he had been instructed by President Bush not to respond to the subpoena. The committee determined by a 7-1 vote that the claim of privilege was invalid. But the Bush Justice Department refused to enforce the subpoena, requiring Congress to turn to the courts. A district court judge appointed by George W. Bush ruled in favor of Congress and against Rove, describing his claim that he was entitled not to appear or respond in any way to the subpoena as ridiculous.

Rove appealed to a Republican panel of the court of appeals which did not address the merits of the case, but stayed the district court’s order because Congress was approaching its adjournment. (By the same reasoning, the subpoenas of grand juries which are about to expire could be considered "moot," but courts regularly enforce these subpoenas. The court of appeals ruling was thinly reasoned and had every sign of being an effort to pull Rove’s chestnuts out of the fire.) Now the tables are turned. The invocation of "executive privilege" is up to the current incumbent in the White House, Barack Obama. No doubt Karl Rove will argue that he continues to operate under the guidance of former president Bush. That position has some precedent (the argument was advanced once by Harry S Truman after he left office, but was never tested), but has generally been viewed as a legal long-shot.

Obama has not addressed the Rove claim directly, but he has made a number of statements suggesting that he did not agree with the Bush Administration’s sweeping claims of executive privilege. Moreover, if Rove refuses to comply with the subpoena, the Holder Justice Department is unlikely to refuse to take enforcement action, as its legal obligation to do so is very clear. In sum, the tables have been turned on Karl Rove. He can continue to refuse to cooperate with Congress in their probe of the U.S. Attorney and Siegelman matters, but not without consequences. If he persists in defying the subpoenas, he may be headed to jail.

The United Nations' crime and drug watchdog has indications that money made in illicit drug trade has been used to keep banks afloat in the global financial crisis, its head was quoted as saying on Sunday. Vienna-based UNODC Executive Director Antonio Maria Costa said in an interview released by Austrian weekly Profil that drug money often became the only available capital when the crisis spiralled out of control last year. "In many instances, drug money is currently the only liquid investment capital," Costa was quoted as saying by Profil. "In the second half of 2008, liquidity was the banking system's main problem and hence liquid capital became an important factor." The United Nations Office on Drugs and Crime had found evidence that "interbank loans were funded by money that originated from drug trade and other illegal activities," Costa was quoted as saying. There were "signs that some banks were rescued in that way." Profil said Costa declined to identify countries or banks which may have received drug money and gave no indication how much cash might be involved. He only said Austria was not on top of his list, Profil said.

In his first annual letter for the Bill & Melinda Gates Foundation, Bill Gates writes that Warren Buffett recently sent him an excerpt from John Maynard Keynes’ essay, “The Great Slump of 1930,” which relates to today’s crisis: “This is a nightmare, which will pass away with the morning. For the resources of nature and men’s devices are just as fertile and productive as they were. The rate of our progress towards solving the material problems of life is not less rapid. We are as capable as before of affording for everyone a high standard of life—high, I mean, compared with, say, twenty years ago—and will soon learn to afford a standard higher still. We were not previously deceived. But today we have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand. The result is that our possibilities of wealth may run to waste for a time—perhaps for a long time.”

As Pattie writes today, the former Microsoft chairman reports a 20% drop in the value of his foundation’s assets last year. But he found a silver lining in the fact that his foundation outperformed most other endowments: “I never thought I would say losing 20 percent is a reasonable result,” he writes. Long-term, Gates is confident. “Innovation in every field—from software and materials science to genetics and energy generation—is moving forward at a pace that can bring real progress in solving big problems,” he says. These innovations will “reinvigorate the world economy.”

Driving through the countryside south of Hanover, it would be easy to miss the GEO600 experiment. From the outside, it doesn't look much: in the corner of a field stands an assortment of boxy temporary buildings, from which two long trenches emerge, at a right angle to each other, covered with corrugated iron. Underneath the metal sheets, however, lies a detector that stretches for 600 metres. For the past seven years, this German set-up has been looking for gravitational waves - ripples in space-time thrown off by super-dense astronomical objects such as neutron stars and black holes. GEO600 has not detected any gravitational waves so far, but it might inadvertently have made the most important discovery in physics for half a century.

For many months, the GEO600 team-members had been scratching their heads over inexplicable noise that is plaguing their giant detector. Then, out of the blue, a researcher approached them with an explanation. In fact, he had even predicted the noise before he knew they were detecting it. According to Craig Hogan, a physicist at the Fermilab particle physics lab in Batavia, Illinois, GEO600 has stumbled upon the fundamental limit of space-time - the point where space-time stops behaving like the smooth continuum Einstein described and instead dissolves into "grains", just as a newspaper photograph dissolves into dots as you zoom in. "It looks like GEO600 is being buffeted by the microscopic quantum convulsions of space-time," says Hogan.

If this doesn't blow your socks off, then Hogan, who has just been appointed director of Fermilab's Center for Particle Astrophysics, has an even bigger shock in store: "If the GEO600 result is what I suspect it is, then we are all living in a giant cosmic hologram." The idea that we live in a hologram probably sounds absurd, but it is a natural extension of our best understanding of black holes, and something with a pretty firm theoretical footing. It has also been surprisingly helpful for physicists wrestling with theories of how the universe works at its most fundamental level. The holograms you find on credit cards and banknotes are etched on two-dimensional plastic films. When light bounces off them, it recreates the appearance of a 3D image. In the 1990s physicists Leonard Susskind and Nobel prizewinner Gerard 't Hooft suggested that the same principle might apply to the universe as a whole. Our everyday experience might itself be a holographic projection of physical processes that take place on a distant, 2D surface.

The "holographic principle" challenges our sensibilities. It seems hard to believe that you woke up, brushed your teeth and are reading this article because of something happening on the boundary of the universe. No one knows what it would mean for us if we really do live in a hologram, yet theorists have good reasons to believe that many aspects of the holographic principle are true. Susskind and 't Hooft's remarkable idea was motivated by ground-breaking work on black holes by Jacob Bekenstein of the Hebrew University of Jerusalem in Israel and Stephen Hawking at the University of Cambridge. In the mid-1970s, Hawking showed that black holes are in fact not entirely "black" but instead slowly emit radiation, which causes them to evaporate and eventually disappear. This poses a puzzle, because Hawking radiation does not convey any information about the interior of a black hole. When the black hole has gone, all the information about the star that collapsed to form the black hole has vanished, which contradicts the widely affirmed principle that information cannot be destroyed. This is known as the black hole information paradox.

Bekenstein's work provided an important clue in resolving the paradox. He discovered that a black hole's entropy - which is synonymous with its information content - is proportional to the surface area of its event horizon. This is the theoretical surface that cloaks the black hole and marks the point of no return for infalling matter or light. Theorists have since shown that microscopic quantum ripples at the event horizon can encode the information inside the black hole, so there is no mysterious information loss as the black hole evaporates. Crucially, this provides a deep physical insight: the 3D information about a precursor star can be completely encoded in the 2D horizon of the subsequent black hole - not unlike the 3D image of an object being encoded in a 2D hologram. Susskind and 't Hooft extended the insight to the universe as a whole on the basis that the cosmos has a horizon too - the boundary from beyond which light has not had time to reach us in the 13.7-billion-year lifespan of the universe.

What's more, work by several string theorists, most notably Juan Maldacena at the Institute for Advanced Study in Princeton, has confirmed that the idea is on the right track. He showed that the physics inside a hypothetical universe with five dimensions and shaped like a Pringle is the same as the physics taking place on the four-dimensional boundary. According to Hogan, the holographic principle radically changes our picture of space-time. Theoretical physicists have long believed that quantum effects will cause space-time to convulse wildly on the tiniest scales. At this magnification, the fabric of space-time becomes grainy and is ultimately made of tiny units rather like pixels, but a hundred billion billion times smaller than a proton. This distance is known as the Planck length, a mere 10-35 metres. The Planck length is far beyond the reach of any conceivable experiment, so nobody dared dream that the graininess of space-time might be discernable.

That is, not until Hogan realised that the holographic principle changes everything. If space-time is a grainy hologram, then you can think of the universe as a sphere whose outer surface is papered in Planck length-sized squares, each containing one bit of information. The holographic principle says that the amount of information papering the outside must match the number of bits contained inside the volume of the universe. Since the volume of the spherical universe is much bigger than its outer surface, how could this be true? Hogan realised that in order to have the same number of bits inside the universe as on the boundary, the world inside must be made up of grains bigger than the Planck length. "Or, to put it another way, a holographic universe is blurry," says Hogan.

This is good news for anyone trying to probe the smallest unit of space-time. "Contrary to all expectations, it brings its microscopic quantum structure within reach of current experiments," says Hogan. So while the Planck length is too small for experiments to detect, the holographic "projection" of that graininess could be much, much larger, at around 10-16 metres. "If you lived inside a hologram, you could tell by measuring the blurring," he says. When Hogan first realised this, he wondered if any experiment might be able to detect the holographic blurriness of space-time. That's where GEO600 comes in. Gravitational wave detectors like GEO600 are essentially fantastically sensitive rulers. The idea is that if a gravitational wave passes through GEO600, it will alternately stretch space in one direction and squeeze it in another. To measure this, the GEO600 team fires a single laser through a half-silvered mirror called a beam splitter. This divides the light into two beams, which pass down the instrument's 600-metre perpendicular arms and bounce back again. The returning light beams merge together at the beam splitter and create an interference pattern of light and dark regions where the light waves either cancel out or reinforce each other. Any shift in the position of those regions tells you that the relative lengths of the arms has changed.

"The key thing is that such experiments are sensitive to changes in the length of the rulers that are far smaller than the diameter of a proton," says Hogan. So would they be able to detect a holographic projection of grainy space-time? Of the five gravitational wave detectors around the world, Hogan realised that the Anglo-German GEO600 experiment ought to be the most sensitive to what he had in mind. He predicted that if the experiment's beam splitter is buffeted by the quantum convulsions of space-time, this will show up in its measurements (Physical Review D, vol 77, p 104031). "This random jitter would cause noise in the laser light signal," says Hogan. In June he sent his prediction to the GEO600 team. "Incredibly, I discovered that the experiment was picking up unexpected noise," says Hogan. GEO600's principal investigator Karsten Danzmann of the Max Planck Institute for Gravitational Physics in Potsdam, Germany, and also the University of Hanover, admits that the excess noise, with frequencies of between 300 and 1500 hertz, had been bothering the team for a long time. He replied to Hogan and sent him a plot of the noise. "It looked exactly the same as my prediction," says Hogan. "It was as if the beam splitter had an extra sideways jitter."

No one - including Hogan - is yet claiming that GEO600 has found evidence that we live in a holographic universe. It is far too soon to say. "There could still be a mundane source of the noise," Hogan admits. Gravitational-wave detectors are extremely sensitive, so those who operate them have to work harder than most to rule out noise. They have to take into account passing clouds, distant traffic, seismological rumbles and many, many other sources that could mask a real signal. "The daily business of improving the sensitivity of these experiments always throws up some excess noise," says Danzmann. "We work to identify its cause, get rid of it and tackle the next source of excess noise." At present there are no clear candidate sources for the noise GEO600 is experiencing. "In this respect I would consider the present situation unpleasant, but not really worrying." For a while, the GEO600 team thought the noise Hogan was interested in was caused by fluctuations in temperature across the beam splitter. However, the team worked out that this could account for only one-third of the noise at most.

Danzmann says several planned upgrades should improve the sensitivity of GEO600 and eliminate some possible experimental sources of excess noise. "If the noise remains where it is now after these measures, then we have to think again," he says. If GEO600 really has discovered holographic noise from quantum convulsions of space-time, then it presents a double-edged sword for gravitational wave researchers. One on hand, the noise will handicap their attempts to detect gravitational waves. On the other, it could represent an even more fundamental discovery. Such a situation would not be unprecedented in physics. Giant detectors built to look for a hypothetical form of radioactivity in which protons decay never found such a thing. Instead, they discovered that neutrinos can change from one type into another - arguably more important because it could tell us how the universe came to be filled with matter and not antimatter (New Scientist, 12 April 2008, p 26). It would be ironic if an instrument built to detect something as vast as astrophysical sources of gravitational waves inadvertently detected the minuscule graininess of space-time. "Speaking as a fundamental physicist, I see discovering holographic noise as far more interesting," says Hogan.

Despite the fact that if Hogan is right, and holographic noise will spoil GEO600's ability to detect gravitational waves, Danzmann is upbeat. "Even if it limits GEO600's sensitivity in some frequency range, it would be a price we would be happy to pay in return for the first detection of the graininess of space-time." he says. "You bet we would be pleased. It would be one of the most remarkable discoveries in a long time." However Danzmann is cautious about Hogan's proposal and believes more theoretical work needs to be done. "It's intriguing," he says. "But it's not really a theory yet, more just an idea." Like many others, Danzmann agrees it is too early to make any definitive claims. "Let's wait and see," he says. "We think it's at least a year too early to get excited." The longer the puzzle remains, however, the stronger the motivation becomes to build a dedicated instrument to probe holographic noise. John Cramer of the University of Washington in Seattle agrees. It was a "lucky accident" that Hogan's predictions could be connected to the GEO600 experiment, he says. "It seems clear that much better experimental investigations could be mounted if they were focused specifically on the measurement and characterisation of holographic noise and related phenomena."

One possibility, according to Hogan, would be to use a device called an atom interferometer. These operate using the same principle as laser-based detectors but use beams made of ultracold atoms rather than laser light. Because atoms can behave as waves with a much smaller wavelength than light, atom interferometers are significantly smaller and therefore cheaper to build than their gravitational-wave-detector counterparts. So what would it mean it if holographic noise has been found? Cramer likens it to the discovery of unexpected noise by an antenna at Bell Labs in New Jersey in 1964. That noise turned out to be the cosmic microwave background, the afterglow of the big bang fireball. "Not only did it earn Arno Penzias and Robert Wilson a Nobel prize, but it confirmed the big bang and opened up a whole field of cosmology," says Cramer. Hogan is more specific. "Forget Quantum of Solace, we would have directly observed the quantum of time," says Hogan. "It's the smallest possible interval of time - the Planck length divided by the speed of light."

More importantly, confirming the holographic principle would be a big help to researchers trying to unite quantum mechanics and Einstein's theory of gravity. Today the most popular approach to quantum gravity is string theory, which researchers hope could describe happenings in the universe at the most fundamental level. But it is not the only show in town. "Holographic space-time is used in certain approaches to quantising gravity that have a strong connection to string theory," says Cramer. "Consequently, some quantum gravity theories might be falsified and others reinforced." Hogan agrees that if the holographic principle is confirmed, it rules out all approaches to quantum gravity that do not incorporate the holographic principle. Conversely, it would be a boost for those that do - including some derived from string theory and something called matrix theory. "Ultimately, we may have our first indication of how space-time emerges out of quantum theory." As serendipitous discoveries go, it's hard to get more ground-breaking than that.

Marcus Chown is the author of Quantum Theory Cannot Hurt You (Faber, 2008)

52 comments:

Anonymous
said...

re wget, try it and you'll find the problem, which is endless downloads of the same page because of the widget and comment ? query string adds to the urls, which can't be filtered by wget rules. I tried, doesn't work, unless you're willing to wait for each page to load x times, x being the number of comments in each posting. Same for widgets.

...how do we keep people from freezing to death, from starving, from cholera epidemics once water systems fail.

This question has been my focus in our [now so-called] home - assuming that the bank will allow us to keep the house, which is not at all guaranteed given the national unemployment and foreclosure outlook. :^(

I have decided that camping skills and equipment must be our family's backup system. The handheld military issue water sanitizers, the below zero fahrenheit sleeping bags, the backpack tents and lightweight cooking equipment, with the exception of the sunoven and the water barrels...and having learned to raise and cook food, even if it's wild forage. Plus our first aid knowledge and strong muscles. I figure we could rent a room from an older couple who has a paid off place in an older neighborhood but not the strength or skills to make it alone. Just maybe we could help each other [and perhaps their unprepared neighbors too] through the long emergency...

Hey, wait a moment, there's quite a difference between Smith ("Even my wife is skeptical of my longstanding calls for housing in ONCE-HOT locales to bottom at 10% - 20% of their bubble-era valuations. " and your assertion that AVERAGE prices will fall to 10-20%. That's about the difference between Calfornia and South Dakota... of course economic desaster areas like Detroit will also decline to 20% of peak.

I just watched the Bailout Rant from yesterdays DR. God help us when the pot runs out.....

In Southern Ontario over the last weekend, two armed robberies of Tim Horton donut shops, one brewers retail and a smash and grab at an LCBO (liquor store)in Cambridge and a pharmacy robbery. In one weekend..... And the real pain hasn't even started here yet. Anyone else notice an increase in this?

It's hard to believe how the DOW hasn't had any major reaction to the bad news in weeks.

How likely is a MAJOR stock market correction imminent? Stoneleigh posted that we would be in a bear market rally in the first quarter of the year or so; is that coming to an end? Would it stay low once it plunged or would it bounce back up quickly?

When looking at economic data and watching how the market reacts, I am often reminded the Upton Sinclair quote "It is difficult to get a man to understand something when his salary depends upon his not understanding it."

Meaning those people those livelihoods depend on the financial services and markets are compelled by subconscious forces to read the data optimistically.

About 6 mo ago, our sheriff announced a pay and hour freeze for all deputies. 3mo ago he announced that there would be enough deputies to cover the county for only 10 hours a day and a 4 hour period (rotated daily) where no deputies would be on duty.Now deputies have to buy their own ammunition for target practice and pay for gas if they go over a certain gallon allotment every month. This was all due to budget cut, he said, while asking for a raise!

The crime rate had doubled in the county, and the criminals keep track of the deputies on duty with cell phones and a buddy so they can rob a place twenty miles away from the nearest cop!

Canada's Min of Finance asked for a blank cheque. He wants the authority to offer " enhancements". The language is priceless. What is an " enhancement"? A commode with legs?Also proud to announce a 200Billion pot of gambling money for any business people who want to leverage up. Flaherty has been completely transparent about his intentions, not advocating a transparency requirement from the financial institutions. That little, or maybe big, dark secret will be buried along side our society.

Everyone let's take a deep breath. Crime was at an historical low during the 1930s in America. It peaked during the late 1980s and 1990s in America. Crime in Canada is not quite of the same volume as your lower 48 states. Criminologists are contrary about the differing explanations for these trends, but there is a sociological phenonmenon known as relative deprivation. If everyone is rich, no increase in property crime and even violent crime. If everyone is poor, no increase. It seems that when some are rich and others wish to to be rich, then those that are not rich will try to take the riches away from those that have them. Also, the frustration of not having riches can encourage people, particularly males, to lash out with violence. It may be to soon to panic over a crime wave, but it is probable that an uptick of property crime will occur within the next year or two and some sensational violence crimes will make the paper. The tipping point will occur when unemployed individuals return to a lifestyle of illicit drug consumption. Drugs will dull the pain of unemployment and provide an alternative source of income for some, while forcing some to commit property crimes to feed their habit if you will.

If you want to preserve these TAE writings beyond nearly any possible censorship, just post them on the Usenet. Google groups is one interface, but it truly sucks these days. It still might be useful as a last resort.

The Usenet is one of the original networks. Very crudely put, a precursor to the Internet. Machines were connected to each other via 1200/2400 baud modems.

So your email would hop from one machine to another, all around the world if you wanted.

And the stuff which is on there has successfully defied the best censorship attempts by Governments world wide.

Stuff is still floating around from 25 years ago. There is no central repository. They knew how to build protocols back then.

Aw, come on now. We will get out of this mess for sure. Every government office and international organization on the planet has produced graph after graph that shows only one possible direction from past to future, from down to up. Without fail year after year...at least from this year forward...

For el gallinazo...After carrying the small,tired 4-year-old girlchild for awhile old bird,,a couple of pianos would have been a break.Men are not designed to carry children..[he quietly whined].

I am wondering now what will be the trigger events that start what will be construed as the end game.The forces of good and righteousness are in overdrive now,and to opposition is minimal.I lisined to Richard Vigery on a radio talkshow today with a tired bit of subtle,and not so subtle race-baiting and low-grade opposition to "the Package".The setup is for "I told you so"when it fails.

What this fool misses is that this economic disaster is firmly pinned on the conservative republicans....Whatever happens.They will be seen as the cause.Never as the fix.I don't think you will ever see his side have power again in my lifetime,after the way they botched running our country the last few years.

People are scared now.They are starting to get the gut feeling of the "Pit and Pendulum" at work now,and all have ask themselves...where am I when they start sorting heads...

Mrs snuffy and I just finished re-working the budget with me on half-time pay.ouch.I should be happy I still have work,but the question is how long before the chainsaw start @the company.

Or something terrible knocks us out of the blue again.It would not surprise me in the slightest to see a really serious whack taken at the USA now...We have not been making a whole lot of friends the last 8 years,Obama aside...

The fear is now everywhere.Downtown here in Portland,Kid wrote a note giving his goods away,calmly took out a pistol,and killed 2 girls outright,and wounded 7 others,then whacked himself.Whoa..

In calf.a man and his wife get fired.They decide to go out as a family...5 dead kids and 2 dead parents...and some supervisors/survivors who made some real bad comments will have nightmares for a long time.... or not.Things are just getting mean now.I think we are going to start seeing a lot more of this kid of shit.And,this is what will prime others to start making the connections to the ones in power who will be held,rightly or wrongly responsible...This is how it will start to get weird.

The comment section on that bailout rant was telling.What one sharp fellow pointed out was that if a "hick"like this man can get his mind around whats happening...the powers that be had better watch out.And better hope he never runs out of weed.The guy was hillbilly,southern,redneck...but not dumb.I would put a side bet he is very familiar with firearms,and may have spent time in the .mil.Pissing off guys like that when you are close enough for them to get their hands on you is a mistake you will only make once.

Couple folks today have pointed out that the people who got us in this mess are not the ones who are mentally capable of getting us out due to having the same mindset that got us in this mess.I am hoping that Obama lets them have enough rope to hang themselves,but keeps it under control...then uses some of that whizbang brain of his to put our collective asses out of this mess,....

With whatever it takes...I hope he takes some time to stop and think some strategy soon.The republican guns are lining up,and its going to get rough soon.

Especially if the world does not co-operate.Which,I fear,it wont. luck

Re: the comment that there is no more credit out there -- I personally know several people who have bought and/or sold houses in the past 18 months. There is not a single instance of a deal falling through because there was no credit out there.

So -- I wonder if there is a credit crunch, or an unwillingness to borrow? Are the banks sitting on piles and piles of rejected loan apps from would-be homeowners and from small businesses?

I don't doubt that there are still some home loans being funded. There are a lot of potential loans not being funded. I had a discussion about credit availability with an associate three weeks ago. He's from Minneapolis, MN and was worked up about how we needed to bailout the banks in order to keep credit available. His reasoning was that he could not find a home equity loan for home improvements he needs to do, even with his stellar credit score (close to 800). I explained why I was opposed to the bailout, and other steps the governement could have taken to soften the blow of economic turmoil - he was moderately receptive to my rationale. That's one example of support for your hypothesis that banks are sitting on cash. They are being very, very picky about funding loans, which means money supply contraction and further missed payments across a wide swath of all types of debt, from credit cards to short-term corporate paper...

While I agree that Obama is super intelligent, my level of hope that he will do the right thing is far less than yours. First, we don't have the time or resources to prove the Keynesians are wrong. We already have him pushing the second $350B of the TARP, a $1T "stimulus" package, and no indication that he will reel in the FED where the serious thievery is taking place. There is also the question of whether he wishes to do the right thing. He may be a wolf in sheepskin. Finally, if he did try to do the right thing, he would probably be whacked. And Biden is a paid for idiot.

As to:

"Or something terrible knocks us out of the blue again.It would not surprise me in the slightest to see a really serious whack taken at the USA now...We have not been making a whole lot of friends the last 8 years,Obama aside..."

I do not wish to start a debate thread here and will not respond to responses to the following observation. Just a take it or ignore it. But when someone with your savvy includes that in a posting, I gotta write something.

David Ray Griffin, the world renowned Protestant theologian, has proven well beyond a reasonable doubt in his book, Debunking 9/11 Debunking, that 9/11 was an inside job. The book is reasoned and logical to the point that it is tedious. There was no way the neocons could invade Iraq and shred the Constitution w/o the 9/11 operation. The Neocon PNAC paper referred to it years in advance as "another Pearl Harbor." The reason that I am rehashing it here is that when one tries to evaluate whether something like this will reoccur, the most logical analysis would be to look to how it would benefit TPTB who really "run" the USA.

With real estate prices dropping for the next 5-10 years, what will happen to the rental market, I'm sure this has been addressed, but I'm trying to wrap my head around what to do...any insight would be welcome. Will rents go up, with all the people foreclosed on, or will they even be able to rent as they will surly be bankrupt?

Personally, I enjoy the science links.However, If you want to learn about the science, then it helps to go read the science paper and find a discussion of the paper.

I dug out the info for the interested readers.http://www.newscientist.com/article/mg20126911.300-our-world-may-be-a-giant-hologram.html?full=trueOur world may be a giant hologram==== http://www.fqxi.org/data/forum-attachments/1_Indeterminacy_of_holographic_quantum_geometry.pdf Indeterminacy of holographic quantum geometryCraig J. HoganUniversity of Chicago and Fermilab(Received 6 June 2008; revised manuscript received 23 September 2008; published 30 October 2008)====== Some explanation and discussion at:http://scienceblogs.com/catdynamics/2009/01/white_noise.phpNew calculations suggest the question of whether the universe is holographic or not is testable, and recent data is consistent with the model, and consistent with the universe actually being holographic===== See my blog at http://www.physicsforums.com/blog.php?b=2====

Yes, there's credit for purchasing houses. This was mentioned in one article this month.

Mostly the activity is underwritten by Freddie or Fannie. Those are the loans at 5% or under. These are VERY restricted right now. E.g. Self Employed Doctors and Lawyers and other high-income people can't get them, because they are self-employed.

One rep of the load industry that I saw on TV a couple days ago said that they were doing loans for about 30-40% of the people who applied these days.

The Banks are underwriting those who Freddie or Fannie won't cover. These rates are about 1-1.5% higher. You'd have to be either a fool or desparate to do that.

Corporate lending is dead, but they are going to try to restart it, as per one of the articles today. We shall see how it goes.

You assert that home prices (I assume on average) will be 10-20% of their peak value. Is that based on the "normal" assumption that home prices follow the buying power over time? In other words: that is how much our buying power will drop.

You assert that home prices (I assume on average) will be 10-20% of their peak value. Is that based on the "normal" assumption that home prices follow the buying power over time? In other words: that is how much our buying power will drop.

Yes. Purchasing power falls off a cliff in a deflationary crash, due to the destruction of credit and shortage of actual cash. That knocks the price support out from under everything.

Property prices and rents will fall precipitously (my guess is AT LEAST 90% on average), but the catch is that fewer people will be able to afford the nominally lower prices then than can afford the higher ones now, as purchasing power will fall faster than price for most people.

People associate things becoming less affordable with inflation, but deflation can accomplish exactly the same thing, only much more abruptly. The essentials will be the least affordable of all, as a much larger percentage of a much smaller money supply chases them preferentially, thereby conferring relative price support (ie those things will be fall in price, but less than everything else).

Almost everyone will be vastly less wealthy than they are today, and they will be far worse off if they are trying to service debt at the high interest rates that will eventually prevail.

Well it really depends on whether you measure buying power in horse power or watts :-)

The drop in prices from peak depend on certain assumptions. Pretty much everyone agrees that prices must drop to no more than 3 times annual family income. Then one must decide whether family median income will increase or decrease. TAE readers would be unanimous in the radical decrease hypothesis. Then there is the huge excess housing inventory stock pushing prices down. Then there are foreclosures continuously adding to this stock.

But the 800 lb gorilla in the room is lack of credit - i.e. mortgages. With no credit, the only people who can think about buying are people with 100% of the price of a house in the bank (or the mattress as there may not be any banks by then). This is a very, very select group, particularly after a couple of years of people trying to live off of their savings. So (pulling these figures out of my cloaca), since 1950 to 2002, maybe 70% of the American public would be eligible for a 20% down mortgage. In 2005, it would be about 98% (eliminating prisoners doing time and child molesters). In 2011, what percentage do you think will be capable of doing a 100% down purchase? As I said, this is the biggest gorilla in the room.

IlargiNext you'll be posting articles about life being an illusion. Or maybe that was one. Good music today. What a brilliant idea to start posting lyrics, too!Kalpa--(Tibetan for "from one big bang until the next").

Ilargi, I am enjoying the science posts as well, particularly the cosmological ones. Let's see; the diameter of the earth is 4.3% of a light second and the universe horizon now is supposed to be 45 billion light years. Does put things in perspective.

For my fellow vultures, I shorted the S&P500 late Monday at about 840 with about 55% of my mad money. Taking a serious hit now. My reasoning was that the British banks are on the verge of collapse and the lousy earning reports are now flooding in. It looked to me there there was a resistance ceiling at about 880. Looks like my timing was off and I'll have to hold them. And to think I could be earning 0.09% interest on 13 week bills!

I love the end pieces about the nature of the universe as well. They're perfect. And having grown up with a physicist father who was fascinated by Many Worlds theories, the mundanities of my life were always punctuated with powerful reminders of our place in the universe - so this is making me feel right at home!

It is taking some measure of self control not to offer my own Cdn Bailout Rant. Suffice to say the leader of the opposition is "swallowing hard " in support of the budget that condemns all the bright students in my critical thinking class to generations of debt slavery. I was stunned to even see them in class. they should be busy bringing down TPTB!And Mr Carney of the Bk of Canada assures there will be no deflation. Must mean he's busy printing,printing,printing...I feel sick,sick,sick...I must be stupid not to understand that building a deck with borrowed money will save the nation. Just what the world needs eh. A deck. I thought the problems were more systemic than that.

I suspect the idea behind the "Bad Bank" will be to shift all,if not most all, losses onto the backs of us, the taxpayer and businesses, and the banks get off somewhat scott-free. I suspect there will be a provision for some losses by the banks, but I also believe alot of "free" money will be handed over to them in the name of "freeing up the credit markets." There seems to be very little commom sense in DC these days, and I feel we will all pay dearly not only in regards as it relates to our wealth but also in our liberty. The Founding Father's must be rolling over in there graves at quite a clip these days. John

For the leader of the opposition to sign off on a blank cheque without any timeframe to a gov't who has broken its word time and again is what I call a " Deep Throat " position. Geez, this it the gov't who destroyed my ballot after it was cast, this is the bully who prorogued the House leaving us adrift with the waters rising!You don't give people like this a blank cheque!!Our only hope in ending the madness is for those who buy gov't debt to stop. It would be an act of compassion, of goodwill toward all.It seems so crystal clear to me that we must live within our means. Haven't studied systems theory yet hold to the idea that extreme weightings such as current levels of debt and unknown agendas stress the system which is why we hear of tipping points. The system response cannot be altered by ideology or belief. Morally neutral in a way.The correction in the system has begun and will only be exacerbated by those on The Hill. This global weighting in favor of " Deep Throat " policy making stresses the system even further. I am so very pissed off!

“In some cases the market held executives accountable for the mortgage crisis. When banks such as Washington Mutual, Merrill Lynch and Lehman Brothers were bought up, many executives lost their jobs. When the government took over mortgage giants Fannie Mae and Freddie Mac, directors and executives were fired.

But the financial bailout has resulted in no such consequences. AP's review of the more than 200 publicly traded banks that received federal bailout money found that about 87 percent of the top three executives in 2006 — typically the chief executive, operating and financial officers — still remain on the job.” Rewarded for Failure Financial Armageddon

Told ya I wasn't a currency trader. You should of bought the franc and shorted the Euro. I still see buying the swiss franc as a bet on the swiss banks. Perhaps all that is required is that they be healthy than the euro area banks. The dollar is rising but what does that tell us about the US?